New Trade – Getting the $LOW Down

by Dan August 6, 2015 2:54 pm • Commentary

Home improvement has been a bright spot in what has emerged as a fairly mixed domestic retail environment in 2015.  The undisputed leader in the space has been The Home Depot (HD), a stock that is up 11% on the year, having just yesterday made a new all time and 52 week high, exactly one year from its 52 week low that it is up almost 50% from those levels:

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

HD has a sort of Teflon feel to it, similar to that of Nike (NKE), Starbucks (SBUX). But so did Apple (AAPL), Disney (DIS) & Time Warner (TWX) prior to their recent 15% declines. I don’t suggest that HD is about to have a similar decline after they report their Q2 results on August 18th, but I would say that a stock trading at 22x expected eps growth of 15%, is not exactly cheap, especially if there is any need for a forward revision. A pull back to $110,  an obvious support level could be in the cards regardless of the results, as it looks like investors are looking to raise cash where they can, and of late that  has meant in prior winners.

But a stock that looks more interesting in playing for a sharp decline in the near term, results or not, is competitor Lowe’s (LOW), which is scheduled to report on Aug 19th.  Last quarter, their miss on earnings and sales stuck out like a sore thumb compared to HD’s beat, with the stock down 4% since and 9% from the 52 week and all time highs made in March.  LOW recently bounced off of technical support just above $65, but the moved has stalled at a time where the 50 day moving average is about to cross below its 200 day moving average, a situation that some technicians call the death cross (circled), a result of waning momentum:

LOW 1yr chart from Bloomberg
LOW 1yr chart from Bloomberg

LOW trades at a slightly lower earnings multiple than that of HD, at 21x expected current fiscal year earnings growth of 19% (actually higher than HD) which could be the impetus for a decline in shares if the company were to disappoint again.

Implied Move for LOW: Short dated options prices seem fair, with the Aug 70 straddle (the call premium plus the put premium) offered at about $2.80 with the stock at $69.50, implying a move below $67.20, or above $72.80 by Aug expiration or about 4% in either direction from $70.  The average one day move for LOW over the last 4 qtrs has been about 4%.  And there’s been a pick up in realized vol over the last few trading days. So here’s the trade:  

Trade: LOW ($69.50) Buy Aug 67.50 / 62.5 Put Spread for .60

– Buy 1 August 67.50 put for .70

– Sell 1 August 62.50 put at .10*

Break-Even on Aug Expiration:

Profits: profits of up to 4.30 below 66.80

Losses: up to .70 above 66.80 with total loss of .60 above 67.50

Rationale: We’re going out of the money slightly on this one considering the moves we’ve seen in large cap stocks like AAPL, TWX, DIS since earnings.  We like the risk reward of playing for a breakdown into an event in what is becoming an increasingly volatile equity environment for no apparent reason.

 

*thought about not selling 62.50 put, but we just looked to offset a bit of decay.  Could make sense to just buy the 67.50 put and sell this put strike as the stock moves lower