Event: Tomorrow before the open The Home Depot (HD) will report Q2 results. The options market is implying a 3.3% one day move, which is in line with the 4 qtr avg move. With the stock at $120, the Aug 120 straddle (the call premium plus the put premium is offered at about $4). If you bought that, and thus the implied move you would need a rally above $124 or below $116 to make money.
Price Action / Technicals: HD is up 14.5% massively outperforming the S&P 500 (SPX) which is up 1.85%, its largest competitor LOW which is only up 5% ytd, and the Consumer Discretionary etf (XLY of which it is the 3rd largest holding) which is up 9.3% ytd.
The stock today is making new all time highs having just broken out above what has been a fairly well defined 6 month base:
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HD 1yr chart from Bloomberg[/caption]
Sentiment: Surprisingly, Wall Street analyst are fairly mixed on the stock with 19 Buy ratings and 13 Holds with a 12 month price target of $125, ir only 4% higher than current levels.
Valuation: HD trades 23x expected fiscal 2016 earnings growth of 15%, on 5% expected sales growth, on a trailing basis HD’s PE is very near a 10 year high:
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from Bloomberg[/caption]
Our View: The stock is expensive relative to itself, but the company is clearly executing well in a fairly challenging retail environment and an unclear housing market. Which brings us to the notion that HD can still do well in a challenged housing market. The theory being those who have traded up may consider home improvement. The fairly easy comparison would be in the auto market, with companies like AutoZone (AZO) and O’Reilly Automotive (ORLY) having both recently broken out to new all time highs, in a healthy auto sales environment, but also very healthy demand for after-market and replacement parts.
The stock is crowded from a holding and investor sentiment standpoint, much like Disney (DIS) prior to its results a couple weeks ago. It faces similar valuation issues too. That said, it’s hard to find too many issues that could derail this breakout.
No matter what your view, options are very cheap for those looking to make a directional bet:
Hypothetical Bullish – Buy the HD ($120.05) Aug 120 calls for $2
Hypothetical Bearish – Buy the HD ($120.05) Aug 120 puts for $1.95
It doesn’t get much easier than that and if you are currently long the stock and looking for protection those puts work. If this stock does indeed break out the losses on that hedge won’t amount to much of the move. And the calls act as a good stock alternative into the event, defining the risk but quickly particpating in any move higher like stock above their breakeven at 121.95.