Event: The Home Depot (HD) reports Q2 results tomorrow before the open. The options market is implying a 3% one day post earnings move, which is in line with the average over the last 4 quarters.
Price Action / Technicals: HD has gained 11% from its post Brexit lows in June, essentially in line with the gains with the S&P 500 (SPX) during the same time period, despite under-performing the broad market on the year (up 3.5% to up 7%), and its peer Lowe’s (LOW) which is up 7% ytd.
The stock has spent the better part of the last year between $125 on the downside, and $135 on the upside, with the stock now consolidating above the prior breakout level, but a tad below the all time highs made earlier in the month:
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HD 1yr chart from Bloomberg[/caption]
Options Volatility Snapshot: Short dated options prices are elevated into the print as one would expect, with 30 day at the money implied volatility at 18.6% (blue below – the price of options), while 30 day at the money realized volatility (white below – how much the stock has been moving) at 3 month lows:
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From Bloomberg[/caption]
My View into the Print: Back in mid May when the company reported Q1 results the stock sold off after as weak comp store sales in the period overshadowed increased revenue guidance.
90% of the company’s sales come from the U.S., so we will not hear much about about currency headwinds. The main concern will be commentary surrounding consumers and the health of housing remodeling.
Consensus has fiscal 2017 earnings growing 15% year over year, on 7% sales growth. If the company were to see a pick up in comp store sales in Q2 and able to guide up, the stock could certainly breakout to new highs. I would be surprised though if the stock were to meaningfully outperform the implied move to the upside as the stock has a tendency to see profit taking post results, even when they are good.
If the company were to whiff on Q2 and guide in line or lower for the balance of the year, investors may view the stock trading 21.6x, and 24x trailing (near a 10 year high) as rich. In this scenario the stock could re-trace some of the stock’s gains since the start of the summer back towards $130 (which looks like decent support at the 200 day moving average).
So what’s the trade?
Bullish: If I were inclined to play for a breakout inline with the implied move, I would definitely define my risk and know what I could lose if the stock is unable to muster new highs. A call butterfly risking just 1.40 fits the bill:
Example: HD ($137) Buy Aug 137 / 142 / 147 call fly for $1.40
- Buy to open 1 Aug 137 call for 2.08
- Sell to open 2 Aug 142 calls at .36 each, or 72 cents total
- Buy to open 1 Aug 147 call for 4 cents
Break-Even on Aug 19th expiration close:
Profits: up to 3.60 between 138.40 and 145.60 with max gain at $142, up about 3.5%
Losses: up to 1.40 between 137 and 138.40 & between 145.60 and 147 with max loss of 1.40, or about 1% below 137 or above 147.
Or
Bearish/Hedge:
If I were inclined to be short (or seek protection for a long) I might give myself a little time for this view to play out, and target $120 on the downside, but out in October.
Example: HD ($137) Buy Oct 135 /120 put spread for $2.80
- Buy to open 1 Oct 135 put at 3.40
- Sell to open 1 Oct 120 put at 60 cents
Break-Even on Oct expiration:
Profits: Between 133.20 and 120 of up to 13.20 with max gain below 120
Losses: up to 2.80 between 133.20 and 135 with max loss of 2.80 above 135