Name That Trade $KBH: Broken Home

by Dan May 19, 2015 3:32 pm • Commentary

Homebuilders and related stocks are having a day today on the heels of the best monthly housing starts since November 2007.  I don’t know about you, but when I hear the term November 2007, I think of another term “the beginning of the end” as the S&P 500 would be cut in half over the next 14 months, from the then all time highs made the prior month.   Was it the spring thaw or the fear of rising rates that caused the surge in homebuilding? I obviously have no clue, but I do think that it’s important to note that aside from moderately better employment data, most of the manufacturing, retail sales and consumer confidence data has been disappointing in the U.S. so far in 2015.

The Hombuilder etf (XHB) is up 70 bps, about half of its opening gains, failing just below the prior 2015 highs:  

[caption id="attachment_53802" align="aligncenter" width="600"]XHB 1yr chart from Bloomberg XHB 1yr chart from Bloomberg[/caption]

Some of the XHB’s components act much better, with KB Home (KBH) up about 3% on the day, but importantly, still down 8.5% on the year and down 20% from its 52 week highs made last summer, and down 40% from the 5 year highs made in early 2013:

[caption id="attachment_53803" align="aligncenter" width="600"]KBH 3yr chart from Bloomberg KBH 3yr chart from Bloomberg[/caption]

It doesn’t take a master technician to see the perfectly formed downtrend that has been in place since the 2013 highs, making a series of lower highs and lower lows.

Options prices have come in hard of late, as realized vol (how much the stock is moving) has ground to a halt, with 30 day at the money implied vol trading at new lows:

[caption id="attachment_53804" align="aligncenter" width="600"]KBH 1yr chart of 30 day at the money implied vol from Bloomberg KBH 1yr chart of 30 day at the money implied vol from Bloomberg[/caption]

My View: If you are inclined to think that the April housing starts data was nothing more than a sharp snap-back from months of weakness during a long cold winter, and that KBH looks like a great short candidate from a technical standpoint, and that options prices are cheap enough to play for a reversal at the downtrend, then you might consider the following trades:

Potential Trade: KBH ($15.12) Buy July 14 Put for .31

Rationale:  Options are cheap, the stock was trading at the strike a week ago and July expiration will catch their next earnings event that could be the next catalyst.

OR Possibly looking at an at the money put spread:

Potential Trade: KBH ($15.12) Buy July 15 / 13 Put for .50

Rationale:  Again Options are cheap, and the break-even is a little tighter on this, but gains are capped at 3x the premium at risk.

TO BE HONEST, I AM NOT IN LOVE WITH EITHER OF THESE TRADES AND WOULD WAIT FOR A BETTER ENTRY AT A FAILURE OF THE DOWNTREND. STAY TUNED