Event: Lennar (LEN) reports their fiscal Q3 results tomorrow before the open. The options market is implying about a 3.5% one day post earnings move, which is rich to the 4 qtr average post earnings move of about 2%, but shy of its 10 year average of 4.75%.
Sentiment: This morning the National Association of Home Builders released data for confidence among its constituents that came in well above the forecast, placing the sentiment gauge very near 1 year highs, per Bloomberg:
Mortgage rates near historic lows and steady job gains are providing firm support for housing demand, providing a boost to economic growth in all but two quarters since the start of 2014. The report indicated builders are confident they will be able to sell more homes but shortages of buildable land and experienced workers are keeping the market from making even greater strides.
Homebuilding stocks (measured by the XHB) are one of the worst sub-sectors in the S&P 500, down about 1/2 percent on the year, and down about 7% from its 52 week highs. The technical set up for the etf (of which LEN makes up 4.25% of the weight) is not great as it just broke down from a one month consolidation in and around $36 and is now sitting on technical support of the uptrend that has been in place since the February lows:
The breakdown at $36 was a result in expectations for a 2016 rate increase from the FOMC, despite the very low probability of such an event prior to their Dec 14th meeting.
When the Fed meets this week, monetary conditions could tighten if they strongly hint to what bond investors like Jeff Gundlach have recently stated as the Fed finally proving that they “are not controlled by the market”. Rates, as they have done of late have moved higher by 25 basis points (on the 10 year Treasury).
My View: tighter monetary policy in the offing, whether implied or acted upon, could be the sort of kryptonite to this group’s already poor relative performance, despite improving sentiment. I’d be shocked if results from LEN did much to change the group’s performance given the uncertainty surrounding interest rates. Remember TOLL Brothers (TOL) reported better than expe3cted fQ3 results on Aug 23rd, the stock rallied nearly 9% that day. But the stock has since given back all of those gains, and is now down 11% on the year:[caption id="attachment_66408" align="aligncenter" width="600"] TOL ytd from Bloomberg[/caption]
Taking a look back at the XHB, and coupled with the relative under-performance, the potential for rates to continue to move a bit higher despite no action by the Fed until December, I see a nasty technical pattern. The five year chart bellow shows the etf right at the breakout level from early 2015, which was technical resistance, now support. Which as stated above is also at the support of the uptrend from the 2016 lows. The 2014 – 2016 double bottom near $28 looks like an attractive downside target.[caption id="attachment_66413" align="aligncenter" width="600"] XHB 5yr chart from Bloomberg[/caption]
So what’s the trade?
*Buy XHB ($34.25) Jan17 34 / 28 Put Spread for $1.25
- Buy 1 Jan17 34 put for 1.55
- Sell 1 Jan17 28 put at 30 cents
Break-Even on Jan17 Expiration:
Profits: up to 4.75 between 32.75 and 28 with max gain of 4.75 below 28
Losses: up to 1.25 between 32.75 and 34 with max loss of 1.25 above 34
Rationale – This trade targets a possible move back to the bounce level the index saw in 2014 and early 2016 with a good risk/reward profile if that were to happen into the end of the year.