D.R. Horton Inc (DHI) is one of the largest homebuilders in the United States. The company focuses on single family units for entry level and first-time homebuyers. With the stock up more than 15% since the beginning of the year, there has been a huge put option play on D.R. Horton for April.
One trader scooped up 78,000 April $14 puts electronically across the major options exchanges. At an average price of 69 cents a contract, the trade would profit if the shares should fall at least 8.7% by expiration April 21. D.R. Horton does not even announce earnings until after April options expire, so this trader is expecting a downward move on the stock very soon.
Before the contract expires, the market will receive two months of housing data, including February and March housing starts and existing-home sales, and February new-home sales. The housing news we have received so far paints a picture of a struggling, but mending recovery.
This is not the only action betting against home builders. At the end of February, Compass Point downgraded five homebuilders, and D.R. Horton was one of them. The homebuilder was downgraded to 'sell' from 'neutral' as Compass Point claims to see a (12%-25%) downside from current equity levels. Compass Point's calculations are based upon weighing the ROEs in their 2012 EPS estimates against the ROIs in a (7%-15%) range. With this in mind, Compass Point does not believe D.R. Horton is a stock even worth holding.
Not everyone believes the stock has reached its high point. Two other financial analysts have different views for the homebuilder. Credit Suisse recently upgraded D.R. Horton to 'outperform' with a price target of 17.25. Williams Financial Group also upgraded it to a 'buy' with a price target of 17.50. In its reasoning it wrote:
"We believe the discipline the company has shown in land inventory management will continue to drive margin improvements and allow flexibility as market conditions turn. Impairments for '11 were $45 million, 1.3% of revenue. 5.6 Years of land supply based on FY12 estimated deliveries."
So there are two different outlooks on homebuilders. Considering the reports continue to show slow, but steady improvement, we see the possibility of the stock rising another 10%, remotely possible but not likely in the short term. We are leaning toward a pullback before it moves up. It has recently grown almost 70% in less than half a year. In the last three weeks it has shot up so quickly, it needs to consolidate. We are not necessarily bearish on the stock, but believe a pullback is likely before it moves into higher territory. We want to play the pullback.
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The options play
One a pullback, we are looking to implement a Bear Put Spread:
- Buy the August 2012 '16' put option (priced at $1.66)
- Sell the August 2012 '15' put option (priced at $1.19)
- Net Debit to Start: $0.47
- Maximum Profit: $0.53
Reasoning behind the trade
- In view of how fast the stock has risen, we see consolidation in the near future.
- It is possible for the stock to pullback clear to 14, since this is the first major point of support.
- A double top in the Bollinger Bands could signal a pullback.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.