I’ve had a lot to say on the retail sector of late (here on the S&P Retail etf XRT), here on Walmart, and here on Amazon’s effects on Department and apparel stores, oh and here). My view is simple, that its not just the wrecking ball that is AMZN wreaking havoc on retailers of late, but also possibly a U.S. consumer that is saving more, or feeling the adverse affect of higher gas at the pump, or leaning towards bigger ticket items like autos, that is weighing on them. Regardless of the reasons at this point, it’s important to note that outliers will always exist, bucking the apparent broad trend. One such stock, that aside from two sharp sell offs in the last year, is The Home Depot (HD), which earlier this week made a new all time high. You could try to extrapolate the recent woes of department stores like Macy’s (M), home-goods stores like Bed Bath & Beyond (BBBY) or appliance seller Whirlpool (WHR) to HD, but it has only been broad market sell offs that have taken this stock down over the past year:
What’s obvious from the 1yr chart above is that the stock has found support at $110 and resistance at $135. The technical set up is pretty interesting, as the stock has made a nice base at prior highs for a month and half threatening a breakout. On the flip-side, if the company were to miss and guide down, there is little technical support until $130 and then $125:
As we head into HD’s Q1 results Tuesday before the market opens, it’s important to consider the implied move in the options market is about 3.5%, above the 2.5% average one day move over the last 4 quarters. HD has declined only 3 times following earnings over the last 12 quarters. Short dated options prices are not exactly that rich considering the earnings event, with 30 day at the money implied vol at 21%, up from the 2016 low of 15%, but down from the Feb high of 37%:
My Take into the Print: If I were long I might consider stock alternatives as the risk reward looks like one up, two down. But that doesn’t exactly mean that I think the stock is going down after the results, merely that the risks are skewed to the downside. So if I were positively disposed to play the stock for a breakout following their results, I would look to do so with defined risk. One of the main reasons for this stance is that prior market leaders like Disney (DIS), Nike (NKE) and Starbucks (SBUX), that all traded at premiums to their peers and the market, have all lagged the broad market and their respective groups in 2016. HD trades at nearly 25x trailing earnings, very near a 10 year high:
IN sum, the chart looks poised for a breakout on a beat and raise and the stock up in line with the implied move of $4.50 in the high $130s, but on a miss and guide down I see the stock down far more than the implied move, possibly as low as $125. For those inclined to be long, spending some premium and defining your risk seems like the way to play. So what’s the trade?
Trade Idea: HD ($133.60) Buy May 134 / 138 / 142 Call Butterfly for $1
- Buy 1 May 134 call for 2.50
- Sell 2 May 138 calls at .80 or 1.60 total
- Buy 1 May 142 call for 10 cents
Break-Even on May Expiration: Profits: up to 3 between 135 and 141 with max gain of 3 at 138, Break-even up just 1% from current levels. Losses: up to 1 between 134 and 135 & between 141 and 142, max loss of 1 below 134 and above 142 Rationale: While options prices appear cheap, they will lose a significant amount of extrinsic value after the earnings event. This trade structure looks to reduce premium outlay while targeting a move higher in line with the implied move while defining risk to the downside.