Nicholas Cavallaro's  Instablog

Nicholas Cavallaro
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Investment professional with experience in equity, credit, and global-macro strategies. Previous roles include working for a mutual fund, hedge fund, and investment advisor.
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  • Tactical Homebuilder Shorts 0 comments
    Jan 24, 2011 9:02 PM | about stocks: NVR, KBH, RYL, MHO, CAA, TOL

    I normally don't post personal trades on SA, but hopefully some of my followers will enlighten me with commentary/suggestions.  Here is a post from my blog,, early this evening:

    Over the past several quarters, I’ve had a bearish perspective on homebuilders. The reasoning for this stance is that homebuilders benefited abnormally from a colossal housing boom and that numerous factors could hinder homebuilders’ performance. Last May, in How a Housing Bubble is Created and the Oncoming Housing Bust, I discussed a gauntlet of harm originating from rising interest rates, the elimination of first-time homebuyer tax credit, unemployment/weak economy, and decreased foreign funding. The elimination of the homebuyer subsidy certainly took the edge off of housing sales since demand was pulled forward, and economic conditions have kept home prices subdued. We haven’t seen much in the way of rising rates, yet this may still be a few quarters away.
    Meanwhile, new market threats have come into play as financing remains weak and conversations on Capitol Hill include abolishing mortgage interest rate deductions. On the credit side, a fierce 23-28% of mortgages are underwater, and a glut of delinquencies and unforeclosed homes still hang on supply. I am equally pessimistic on the economy, since growth typically follows periods of high real interest rates, not the current depressed/negative real rates that we have.
    To capitalize on this hostile situation, I historically shorted or purchased put options on ITB, an exchange traded fund comprised of homebuilders. However, using this security alone no longer seems to be the best maneuver since some companies in this fund are profiting from the downturn. Reasonably thinking, betting against such best-of-breed stocks like NVR and Toll Brothers seems imprudent. Instead, I am refining my tactic by betting smaller amounts against a broader number of weaker homebuilder stocks. ITB put options will accompany these positions.
    After mulling through a handful of analyst reports from S&P, Morningstar, and Zelman, a few themes stand out. First, no matter how you slice it, NVR performs head and shoulders above its peers. Its asset light model is profitable even in market downturns. This is not a stock to bet against. Second, the analyst’s macroeconomic, top-down perspective dictates how homebuilders fare. Now, this may seem obvious, but consider the chart below; S&P currently views the homebuilders industry as negative while Morningstar and Zelman are a bit more optimistic. Third, location matters. This is a gimmie in local real estate, but the same holds true nationwide; the Sunbelt states, notably Arizona, Nevada, and Florida, will have far greater delinquencies and depressed demand than other areas. Homebuilders with exposure here will struggle.

    Today’s trades:
    Bought 1 NVR @ $779.00
    Shorted 75 KBH @ $15.05
    Shorted 50 RYL @ $17.60
    Shorted 65 MHO @ $15.10
    Bought 2 SPF 9 Sep11 puts @ $4.60
    I also made a few bids to marginally increase my ITB position, but they ended the day unfilled.  I may try again as the week progresses.  I will update the Top Five after these trades execute or at the end of the week.
    Stocks: NVR, KBH, RYL, MHO, CAA, TOL
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