Thirty day at the money implied volatility (price of options) in the S&P 500 index has neared its 2 year high in the last week, accompanying the increase in realized volatility (how much the underlying is moving) that we have seen. Here is 30 day implied volatility vs. 10 day realized volatility in the index in the past 2 years:
The rapid increase in options pricing has generally been an opportunity to fade the move over the past 2 years, so many traders are naturally looking at buying stocks and selling options in the past 2 days.
We are less comfortable with that strategy given the serious macro headwinds and the continued negative breadth. After yesterday’s selloff, the percentage of NYSE stocks trading above their 200 day moving average is now at a 2 year low:
This selloff doesn’t exactly look like the prior selloffs of the past 2 years in terms of internals, so our hunch is that the volatility profile might not follow the usual script either.
However, with VIX futures already in the high teens, we don’t see a favorable trade in the VIX that offers good risk/reward. Instead, we’ve been focusing on some of the large cap winners where implied volatility is still low and investors are using them as safe havens as they sell higher beta names. Our trade idea on DIS last month was a good example of that.
After screening through the large cap names, HD is the one name that stood out to me as a stock that is near its all-time highs, and its implied volatility is only near the midpoint of its 2 year range:[caption id="attachment_46630" align="alignnone" width="600"] HD 30 day implied vol, courtesy of Bloomberg[/caption]
Most other stocks currently sport implied volatility levels near 2 year highs. Moreover, HD is hardly a consumer staple or utility stock, which have acted defensively in the past week. HD is a hideout stock for fund managers, and if broader market selling continues over the next month, HD is likely going to see some downside volatility as well.
HD actually made a new all-time high intraday yesterday, and has held up exceptionally well since its breakout on a strong earnings report in August:[caption id="attachment_46635" align="alignnone" width="600"] HD daily chart, courtesy of Bloomberg[/caption]
However, the stock is more than 10% above the breakout level, so there is plenty of room for HD to fall if selling picks up.
In the meantime, the housing-related stocks as a whole have actually been getting hit hard, and XHB made a new 52 week low today:[caption id="attachment_46636" align="alignnone" width="600"] XHB daily chart, courtesy of Bloomberg[/caption]
While Home Depot has certainly done a better job managing its business than other companies in the sector, the sector weakness indicates that the backdrop for housing-related spending is far from healthy. Also here is another example of a company that is very effectively managing their balance sheet, and thus their earnings. Last December the company did an accelerated share buyback to the tune of $3 billion and then in early June the company issued $2 billion in debt to buy back more stock. The result of solid execution and lowered share count has helped the company achieve fantastic earnings growth near 20% year over year, despite sales growth in the mid single digits. This is a trend that we don’t think can continue, meaning lever up to buyback shares in a tepid sales growth environment.
The trade that we considered was the Feb 90/80 put spread for around $2.00 in HD (with stock around $$93.40). That trade has more than 4 months to expiration, takes advantage of the reasonably low implied volatility, and would be a nice winner on a retrace back to the $85 level at some point in the next few months. We already have a number of bearish positions of this nature on at the moment, so we are going to put this one on the watch list for a time when we see some market strength.