Trade Update – $XHB: Closing Calendar for a Profit

by CC July 18, 2014 2:41 pm • Commentary

About a month ago we placed a mildly bearish trade in XHB with the thought that it could decline below its moving averages and settle near the 31 level. With the front month short option expiring today and the ETF at possibly a near term over sold situation it make sense to take the profits and move on in the structure:

ACTION – XHB (30.95) sell to close the July/Sept 31 put calendar at .97 for a .27 profit

– Buy to close 1 July 31 put for .10

– Sell to close 1 Sept 31 put at 1.07

The profits on this trade are almost entirely a result of the decay in the July options. We had the thought of possibly continuing to roll this calendar but we’re not entirely positive it’s a great entry point to add short deltas and would rather enter a bearish trade from somewhere higher in the ETF.


Housing stocks, both builders and related retailers (represented by the XHB, down 2.65% in ’14), have been some of the worst performing stocks year to date.  As you can see in the graph below (courtesy of Global Macro Monitor) nearly every other sector in the U.S. stock market is green for 2014:



Earlier this week, we got a look at May Housing Starts that saw a big month-over-month drop and greater than expected year-over-year decline.  That report highlighted what many would agree is a challenged environment for home-builders who are dependent on single family home formation.

Investors in homebuilders and related stocks don’t seem to know what to do with them in an uncertain interest rate environment.  The yield on the 10 year Treasury has been banging around between 3% in early January, and 2.5% in late May and now trying to get back to the midpoint as the Fed carefully walks a fine line of trying to talk up rates ever so slightly without causing the sort of panic seen in May/June 2013.

Either way, I have a dim view for housing this year. If the economy truly is improving as the Fed thinks, and the Taper comes to an end in the Fall, then rates should increase as traders will front run what will be an eventual bump to fed funds.  This rate increase could strain the housing market.  On the flip side, if the Fed’s forecast for continued gradual growth are wrong, and their Taper of bond buying was an incorrect strategy and rates decline, then it will because the economy is weaker than they thought.  Again, that’s not likely a great environment for home sales.  Either way you look at it, the likelihood of a dramatic pick up for the housing market is not great anytime soon as it would depend on almost perfect timing in the exit of the Fed’s accomodative policies.

Over the last week or so, we highlighted some large out of the money put buying in Dec in the XHB in our Too Many Options posts:

From June 12th:

XHB – Buyer throughout the day of over 150k of the Dec 26 puts for 0.425 average price.  That’s around $6.5 million in total premium, and the trade is only profitable if XHB trades below $25.575 by December expiry.  XHB last traded below that level in December 2012.  Implied volatility between 0.5 and 1 point higher 6 months out, depending on the strike.  Jeff Gundlach recommended a short XHB position at the May Ira Sohn conference.

From June 16th:

XHB – More buying of the December 26 puts, this time paying 0.45 for 70k.  XHB is one of the few sector ETFs that is negative in 2014.  The ETF has traded in the $28 – $34 range for much of the past year.

So there is a big bear out there buying far downside puts in XHB that expire in December.  Meanwhile, Jeff Gundlach recommended shorting XHB as his idea of the year at the Ira Sohn conference.  Blindly trading off of hedge fund recommendations is hardly a strategy that we prefer, but we respect Gundlach and find his willingness to make his opinion public noteworthy at the least.

Technically, XHB has been able to break out of its 2013 range, when it traded between $28 and $32.75 for almost the entire year:

XHB daily chart, 50 day ma in pink, 200 day ma in yellow, Courtesy of Bloomberg
XHB daily chart, 50 day ma in pink, 200 day ma in yellow, Courtesy of Bloomberg

The 50 day and 200 day moving averages are relatively flat, and both around $31.50 to $32, near where XHB is trading today.  On the upside, a move above $32.75 would put the bear case on ice for the moment, while a break of $31.50 would put $30 and then $28 back in play.

Like so many other names, XHB options are priced near 2 year lows:

XHB 30 day implied volatility, Courtesy of Bloomberg
XHB 30 day implied volatility, Courtesy of Bloomberg

And that’s even with the huge December put buyer over the past couple of weeks.

So fundamentally a bad outlook for the sector, under-performance so far in 2014, a range-bound technical situation with XHB near the high end of that range, and cheap option pricing. But as with most things in the market, we’ll need to protect against short term decay as realized volatility across the board is so low. So here’s the trade:

TRADE – XHB ($32.00) Buy the July/September 31 put calendar for .70

– Sell to open 1 July 31 put at .30

– Buy to open 1 Sept 31 put for 1.00

Break-evens on July expiration: Max profits with stock at $31 on July expiration, losses of up to .70 if stock is significantly higher or lower than $31 on July expiration.

Rationale – This Summer could mark an inflection point for the homebuilders as we get a better sense whether or not there is another leg in the multi-year housing recovery. This trade structure plays for some movement lower in the ETF while protecting against the low vol/ boring market we are currently in.