Doin’ The Home Depot (HD)

by Dan September 7, 2016 3:48 pm • Trade Ideas

The Home Depot (HD) has been the poster-child for the re-emergence of the U.S. housing market and the resilience of the U.S. consumer.  Despite the stock being flat on the year, it is up 650% from its lows in the throws of the financial crisis in 2009, vs the S&P 500 (SPX) which is up 225%.  While the jury is still out on the health of the U.S. consumer despite mildly improving employment data since the Spring, shares of HD have stalled out a tad after making a new all time high in early August, failing to keep pace with the broad market.  That said, the two higher highs made in May and early August are nothing short of impressive, despite little apparent technical support till $125:

HD 1yr chart from Bloomberg
HD 1yr chart from Bloomberg

Sentiment toward’s retail stocks (ex Amazon of course) has been fairly mixed of late, with Costco (COST), Lowe’s (LOW) and TJ Maxx (TJX) all seeing significant earnings gaps lower from very near 52 week highs in just the last few weeks.

At first blush, HD trading 21x consensus fiscal 2017 eps growing of 15%, on expected sales growth of 17% year over year, falls into a sort of growth at a reasonable price category. But when you consider that 15% eps growth is not an insignificant step down from the prior three year average of 21%, the stock could appear expensive to the market, its peers and its own history.  

The next identifiable catalyst for the shares (aside from speaking tomorrow morning at Goldman Sach’s retail conference) is the company’s fiscal Q3 results due Nov 13th prior to the open.

If you thought HD could re-test technical support at $125, and want to use the next earnings event as a catalyst, you might consider one of the following two defined risk options plays.

First, keeping it simple, a vertical put spread:

HD ($132.80) Buy Nov 130 / 125 put spread for $1.20
  • Buy 1 Nov 130 put for 2.80
  • Sell 1 Nov 125 put at 1.60

Break-even on Nov Expiration:

Profits: up to 3.80 between 128.80 and 125 with max gain of 3.80 (3x premium at risk) at 125 or lower.

Losses: up to 1.20 between 128.80 and 130 with max loss of 1.20 at 130 or higher, risking less than 1% of the stock price.

Rationale: this is simple risk what you’re willing to lose. The potential reward and a breakdown in the stock is more than 3 times what’s risked if it is at or below 125 on November expiration. That’s not too far away considering the chart and it capturing an earnings event.


Or Look to finance Nov puts with the sale of near dated puts with a put calendar:

HD ($132.80) Buy Sept / Nov 130 put calendar for $2.45
  • Sell 1 Sept 130 put at 35 cents
  • Buy 1 Nov 130 put for 2.80

Break-even on Sept Expiration:

Max profit at 130 on Sept expiration with the ability to then spread the November puts and further reduce premium risk. Ideally, the stock sells off towards 130, Sept 130 put expires worthless and then you’ve financed a bit the Nov 130 puts. The risk to the trade is that the stock goes higher from here into September expiration in which case the sale of the September puts will not be enough to make up for losses in the November puts. There’s also risk of the stock collapsing below support before September expiration, but this trade will be profitable even if that happens as long as the stock isn’t too far below the 130 strike in the next 2 weeks.

Rationale: this gives a little more flexibility in that any move towards 130 in the next week and change means better prices on an October or November put sale against the Nov 130 puts. The key is isolating November, while defining risk and fighting decay in the meantime.