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Homebuilder DR Horton (NYSE:DHI) has a significant competitive advantage over its smaller rivals, as the company has capital available for financing home construction, where its smaller rivals are largely dependent upon banks, which are still reluctant to give out loans at this point. The large/small financing issue as noted by DR Horton in its Q3 2012 earnings call held on July 27, 2012 was largely in agreement with Home Depot's (NYSE:HD) assessment of the situation as discussed in this article.

DR Horton is the largest U.S. based homebuilder for the 10th consecutive year and reported net sales order growth of 25% year-over-year and 3% sequentially. The company reported its average sales price increased by 5% year-over-year and 2.5% sequentially.

The company forecast stronger closing and pretax profit in Q4 for both sequential and year-over-year. DR Horton considers itself as being in its best position as compared to the last 29 years, which is a pretty strong statement, but is understandable with the carnage in the rear-view mirror.

DR Horton's stock price has gone ballistic over the last 10 months or so as shown below:

The company's stock price recently peaked around $19 and has pulled back to around the $17 range.

With the company's earnings report in the rear-view mirror, housing market in an apparent recovery and the company's strong competitive advantage, a bullish position is considered for the company. A bullish position to consider is a bull-put credit spread. A bull-put credit spread can be entered by selling on put option and purchasing a second put option further out-of-the-money.

Using PowerOptions tools a number of potential bull-put credit spread positions are available as shown below:

(click to enlarge)

The 2012 Sep 13/15 bull-put credit spread is attractive, as it has a potential return of 9.9% (78.5% annualized) and a 14.2% separation between the underlying and the strike price of the short put option. The 2012 Sep 12/14 bull-put credit has a potential return of 4.2% which is kind of on fringe/low side for consideration. The 2012 Sep 14/16 has a nice potential return of 17.6% (140% annualized), but the separation between the underlying and the strike price for the short put option is 8.5% which is worthy of consideration, but might require a little too much management for me.

To enter the 2012 Sep 13/15 bull-put credit spread, the 2012 Sep 15 put option is sold for $0.24 and the 2012 Sep 13 put option is purchased for $0.06.

Bull-Put Credit Spread Trade

  • Sell DHI 2012 Sep 15 Put at $0.24
  • Buy DHI 2012 Sep 13 Put at $0.06

A profit/loss graph for one contract of the DR Horton bull-put credit spread is shown below:

If the price of the stock is greater than the $15 strike price of the short put option at expiration in September of 2012, the position will be fully profitable. If the price of the stock is less than the $13 strike price of the long put option at expiration in September of 2012, the position will result in a total loss of capital, however, the position should be managed prior to experiencing a complete loss.

A management point of $16 is set for the position. If the price of the stock drops below $16, the position should be managed for an exit or a roll.

Source: Bullish On DR Horton