Trade Idea – $HD: More Doing

by Dan November 16, 2015 3:09 pm • Commentary

Event: The Home Depot (HD) reports Q3 results tomorrow before the opening. The options market is implying about a 3.5% one day move, which is rich to the 4 qtr avg move of about 2.6%. The 10 year average post earnings move is a little less than 3%.

With the stock at $120, the Nov 20th weekly 120 straddle (the call premium plus the put premium) is offered at $4.60. If you bought that, and thus the implied move, you would need a move above $124.60 or below $115.40 to make money, or about 3.85%.

Price Action / Technicals:  Despite HD’s 5% decline since making an all time high on Nov 9th, the stock is still up 15% on the year, massively out performing the S&P 500 (SPX), down about 1% ytd, and most of its peers, with the XRT, the S&P retail etf, down 11% on the year.

Since HD’s epic breakout in Aug 2014 to new all time highs, which yielded more than 50% gains to the recent highs, the stock has held the very steep uptrend, except for the one day blip on Aug 24th. The stock is now approaching near term support, but the level to keep a close eye on would be the uptrend at $116:

HD 2yr chart from Bloomberg
HD 2yr chart from Bloomberg

My Take:

HD shares have traded at a premium to the broad market and its peers for most of the recovery of the last 6 years.  The stock currently trades 24x trailing earnings, very near a 10 year high, 22.6x the current fiscal year’s expected earnings, which are expected to grow 16%, on 5% sales growth.  This is pretty much in line with the multiple of competitor Lowe’s (LOW).  I think it is safe to say that both stocks are priced to perfection in the face of what is increasingly looking like a challenged retail sales environment.  That said, aside from the stock’s short lived crashed from its then highs in mid August, HD has been relatively immune to the whims of the US consumer, little exposure to the strength of the dollar, and the jury is still out what a rate increase would mean for the home improvement retailer.

If the company were to miss and guide down, the stock would easily be down in line with the implied move, testing the uptrend.  At that point the stock would likely be a sell on rallies.

If the company were to print and inline q3 or a beat and raise guidance then the stock likely re-traces the 4-5% decline of the last week and is once again threatening new highs.

Potential Trade:  For those that think the stock under-performs the implied move, and remains within the recent bands, the following Defined Risk Short Premium Trade could make sense:

HD ($120.40) Buy the November 115/120/125 call fly for 1.60

Rationale – This is a defined risk, short premium, short vol trade that looks for HD to close between 116.60 and 123.40 on Friday’s expiration. It risks 1.60 to make up to 3.40. The risk is a move of more than $5 in either direction that puts the entire 1.60 at risk. This is entirely a mathematical probability trade and with all event range trades it can be very wrong instantly. So as with any event trade it’s not for the faint of heart and must be considered only along with the intent of an overall short premium strategy over time.