Home Depot/Lowe's Pair Trade - Hedged Opportunity For Housing Despair

As the blood runs in the streets for the housing market, the current Home Depot (HD)/ Lowe's (LOW) pair trade offers your portfolio a hedged opportunity.

Before I get into the details, Exhibit 1 is a company overview comparison chart.

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Exhibit 1

I would also like to include the latest analyst price targets for both companies, Exhibit 2 sourced from Yahoo Finance.

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Exhibit 2

The current stock price ratio for LOW/HD is 0.811 ($31.06/$38.31) The current mean analyst price ratio target is 0.873 ($37.31/42.73)

In Exhibit 3, I have plotted the LOW/HD stock price ratio on a line chart. You will see that this ratio was just recently at the mean analyst price targets of 0.871, but has dropped to the 20-day average.

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Exhibit 3

In my opinion, I feel this is a good opportunity to enter in a pair trade up to the pair ratio reaches the mean analyst price target of 0.873 ratio.

Here are the details of the paper trade:

Buy 322 shares of LOW at $31.06 = 10,001 Sell Short 261 shares of HD at $38.31 = 9,999 This is a cash neutral hedge with the cash outflow on the LOW purchase and the inflow on the HD short sale.

If this trade is successful, it will provide a +4.1% return after commissions. I will calculate the annual percent rate when I exit the trade.

Disclosure: Author is neither long nor short HD or LOW.

Comments

[StatGury:]

Nice math guy but would you have written your follow up article if the same pair had caused you a loss of $700 instead of a gain of $700. An infinite% gain looks good but an infinite% loss hurts a lot. Plus your math is wrong. You say that your pair trade will fetch 4.1%. Actually it will fetched infinite percent (assuming that you can convince your aunt to pay the first two commisisons). Where is your statutory warning?

Internet and blogging has given birth to so many financial charlatans. God save your readers.

2007 Sep 18 04:32 AM

[Elias Tsepo...:]

In response to the anticipated % gain, 4.1% represented net gain but before taxes against the total amount of capital deployed. In my initial article, investing $20,000 ($10,000 on each trade)and returning ~$800. I don't agree that the gain will by an infinte % becuase you should peg your gain against capital employed, also there isn't a broker that will allow you.

2007 Sep 20 11:01 PM