Annotated article summary from this weekend's Barron's. Receive all our Barron's summaries by signing up here:
Subprime Spillover by Kopin Tan
Summary: Even though subprime loans are a small percentage of all mortgages, credit-tightening standards that are being initiated in the wake of subprime fallout is still likely to affect home demand and prices. StreetTRACKS SPDR Homebuilders ETF (NYSEARCA:XHB) is down 10% since early February, and may not have hit bottom yet: Goldman Sachs recently lowered its odds for a 'better-than-expected' spring selling season from 20% to 10%. "Impatient bulls" may consider selling out-of-the-money puts at prices at or below companies' book value, which should provide some degree of safety from further fallout. Michael Benhamou of Louis Capital says that credit tightening will be particularly harsh on the lower-end of the borrowing spectrum, so luxury homebuilders like Toll Brothers Inc. (NYSE:TOL) [average home price $690,000] should fare better than bargain builders like KB Home (NYSE:KBH) [$277,000] -- he reckons Toll will outperform KB Homes by 15% over the next three months. KB Homes currently trades at 52% over tangible book value, a premium on other homebuilders, some of which are trading at just 10-20% above. Barron's says traders looking to capitalize on a TOL/KBH divergence could sell TOL puts and use the proceeds to buy comparable puts on KBH.