New Trade $HD: Home Improvement Trend Closer To The Beginning or the End of A Cycle?

by Dan October 11, 2013 1:44 pm • Commentary

HD as been a monster ytd, a posterchild for all the FOMC’s hardwork over the last few years.  But since the May/June “TaperTantrum” HD has not kept pace with the SPX, and failed to come close to making a new high last month with every major index.  Obviously higher rates are weighing a bit on the housing trade, and as Business Insider succinctly pointed out this morning (here), JPM and WFC Q3 results don’t speak to an uptick in applications or originations, from JPM release, per BI:

Mortgage origination were $40.5 billion, down 14% from the prior year and 17% from the prior quarter, including purchase originations of $20.0 billion, up 57% from the prior year and 15% from the prior quarter.

Additionally, mortgage application volume was down 45% from the prior year and 38% from the prior quarter.

The Technical set up for HD is not horrible but the stock is forming a bit of a triangle that is likely to be resolved some time fairly soon.  The lack of momentum of late is a bit troubling, highlighted by its declining 50 day moving average (purple line below) and the series of lower highs since May.

HD 1 yr chart from Bloomberg
HD 1 yr chart from Bloomberg

The stock’s strength today is clearing bucking the trend of broad retail weakness, but my sense is that rates will continue to stay bid, regardless of Yellen’s appointment to be the next Fed Chairwoman, and that a continuation of the government shutdown will weigh on consumer confidence all adding up to softening activity in the housing market.  But the BULL CASE is predicated on the notion that there remains a tremendous backlog of home improvement that does not rely on new and used home purchases.  This is not a trend that I would want to be short in the long run, but like the idea of setting up to own Dec near the money Puts for their Q3 results expected Nov 19th.

TRADE:  HD ($76.54) Bought Nov / Dec 75 Put Calendar for 1.20

-Sold 1 Nov 75 Put at 1.10

-Bought 1 Dec 75 Put for 2.30

Break-Even on Nov Expiration:

Profits are maximized at $75. Slight moves above and below that strike are also profitable with big moves higher or lower putting the structure at risk of losses on expiration.

-Maximum risk is 1.20

Trade Rationale:  Despite IV coming in this week across the board, single stock IV remains high, this structure helps finance owning the downside puts for the event that will fall in Dec expiration.