In early February we expressed a bearish view in shares of The Home Depot (HD) and closed for a profit after a drop in the stock (read here). Following this morning’s very strong earnings results the stock is once again trading back at our short entry level from February. In February we got our timing right largely due to the overall market swoon and took the trade off for a profit with an assist from the broad market weakness. Here was our reasoning for the initial trade on Feb 2nd:
The company has been one the largest corporate beneficiaries of the U.S Federal Reserve’s unprecedented monetary policy since the crash of the real estate market last decade. But here is the thing, almost every Fed induced bubble is kind of coming apart. And given the horrible poor performance of homebuilding stocks of late (the XHB, the S&P Homebuilders etf is down 25% from its 52 week highs and the ITB, iShares Home Construction etf is down 21% from its 52 week highs), I am hard pressed to think that HD can continue to defy gravity as other sectors in the U.S. that are economically sensitive like autos and transports implode. Yeah the stock has bucked all of the prior headfakes lower of the last few years, but the broad based weakness in almost every sector in the S&P 500 except for defensive sectors like Utilities, Telco and Consumer staples leads me to believe the jig is near up for U.S. stocks.
HD buys back a ton of their own stock, pays a dividend which yields 1.88%, exactly what the 10 year Treasury gives you, trades at 23.4x expected 2016 eps growth of 17%, despite a mere 6% revenue growth. The stock is expensive to retail peers and the broad market, and if the company were to guide the current year down, the stock could see a re-rating.
The next identifiable event will be fiscal Q4 results on Feb 23rd.
Does the solid report and guidance change our view now? Not really. I’m not sure who the incremental buyer of the stock is here. And after the stock’s rip from earlier in the month from $110, its feeling a bit exhausted, I could see a re-test of the 200 day moving average int the coming days:
And possibly a re-test of $110 in the coming weeks or even a re-test of the long term uptrend in the coming months:
With the news out of the way, and the possibility of the broad market rally petering out, we think a re-short makes sense at current levels.
So what’s the trade?
*Trade: HD ($125.50) Buy March 125 / 115/ 105 Put Butterfly 1.65
-Buy to open 1 March 125 put for $3
-Sell to open 2 March 115 puts at .75 each or $1.50 total
-Buy to open 1 March 105 put for .15
Break-even on March Expiration:
Profits: up to 8.35 between 123.35 and 106.65 with max gain of 8.35 at 115
Losses: up to 1.65 between 123.35 and 125 & between 106.65 and 105 with max loss of 1.65 (or just more than 1% of the stock price) below 105 and above 115.
Rationale:
This is an inexpensive defined risk trade playing for a pullback in the next few weeks. The risk/reward is very favorable and vol is cheap following the event.