In the home improvement sector both shares of Home Depot (HD) and Lowe's (LOW) have risen over 20% year to date and have been strong market performers. There are currently ten trading days left in this brutal "sell in May and go away," and in the long term both Home Depot and Lowe's are poised to run higher on an improving housing market, but in the short term when there are broad market sell-offs (as investors have seen in the month of May) the market will naturally affect strong market performing companies.
With the S&P 500 and the Dow Jones in a slump lately, investors may wonder how earnings combined with bearish tones in the market may affect their company. Even if a company gives a positive earnings report the companies stock can still sell off as investors might look to a variety of reasons to take profits. Rather than try and figure out where the market is going and if the company one is considering will report positive earnings, in my opinion non-directional strategies are the way to go.
On April 27, 2012 I published a non-directional option strategy "Trading Home Depot's Upcoming Earnings Using Options" and for those who bought in at under a dollar per strangle, the trade is now worth $264 as Home Depot has pulled back from their highs and the markets have seen a lot of selling lately. One of the great things about non-directional strategies is that investors will not need to worry about what direction a stock goes into as long as a stock makes a certain % movement in either direction.
Lowe's is a home improvement retailer that has stores in the United States, Canada and Mexico. Lowe's caters to the do-it-yourself individual, construction companies and residential properties and since the beginning of the year Lowes has been trading in the same direction as Home Depot. Lowe's reports earnings on May 21, 2012 and with the markets in a downbeat and uncertainty on how the market might react to Lowe's upcoming earnings investors should consider using a non-directional strategy for Lowe's.
When taking a look at a year to date chart of Lowe's investors will notice that Lowe's is almost in the middle of where it started out in the beginning of the year at $25.52 compared to this year's high at $32.10 per share. With Lowe's in the middle of where it started at in the beginning of the year, it's possible with positive earnings the stock could climb back into the $30 price range or the sell-off could continue. When also looking at the chart below investors will notice that Lowe's is below their 50 day moving average and briefly below their 100 day moving averages. On a technical basis if Lowe's continues to sell-off the stock could pull back to the $27 level that was a decent level of support from late January 2012 to February 28, 2012 before the stock broke to the upside.
Lowe's and Home Depot generally trade side by side since they have similar business models in the same sector. On Home Depot's last earnings report the company reported earnings per share of 0.65 which was in line with expectations, but since Home Depot reported earnings on May 15, 2012 the stock is down $2.85 or 5.5% The Home Depot earnings release was generally positive, but Home Depot missed revenue by 130 million and comparable store sales came in at 5.8% year over year versus 7.0% expected. In my opinion expectations might have been too high for Home Depot and it's possible that the same fate might happen for Lowe's.
Trade Idea: Buy June 29/28 Strangle
Buy (1) June 29 call = 0.88 or (0.88 x 100 = 88)
Buy (1) June 28 put = 0.82 or (0.82 x 100 = 82)
Total Cost Based on a 1:1 Ratio = $1.70 ($1.70 x 100 = $170)
Max Loss = $170
Upper Breakeven Point = Upper Breakeven Point = Strike Price of Long Call + Net Premium Paid =$29.88
Lower Breakeven Point = Lower Breakeven Point = Strike Price of Long Put - Net Premium Paid = $27.18
In conclusion, I picked June since Lowe's will report before May's expiration and June also give investors more time for the trade to be profitable. In this trade investors will need at least a 4.5% move to the upside or downside to make a decent profit. While a 4.5% profit move may seem a lot, Lowe's was down 3.24% today on May 16, 2012 and with earnings coming near this trade allows investors to possibly take advantage of upcoming volatility as earnings come near rather than making a directional bet.
Disclosure: I am long LOW.
Additional disclosure: Currently playing the June 28/29 June strangle