Trading Options On Home Improvement Retailers' Upcoming Earnings: Lowe's And Home Depot

Includes: HD, LOW
by: John R. Conway

This year to date both shares of Home Depot (HD) and Lowe's (LOW) have been performing up to expectations on continued improvements in housing data, sales and consumers who want to continually improve their home. Home Depot and Lowe's have also benefited from a mild winter this year that leads consumers into their spring buying earlier than anticipated. On April 27th I presented an options trade for how to trade Home Depot's earnings and then on May 18th I decided to also trade Home Depot's rival Lowe's using options. With earnings coming up for Home Depot and Lowe's I am once again looking to use a non-directional options strategy.

When trading options if a particular strategy continues to work on a stock or sector then in my opinion there is no reason to deviate from the strategy. When trading a company's earnings the only strategy I prefer to use are non-directional strategies since earnings can be volatile and the short time frame investors have to trade around. Home Depot last reported earnings on May 15, 2012 of 0.65 per share that met analysts' expectations. On Home Depot's last earnings report the company updated their fiscal 2012 guidance and is continuing to see strong sales. Home Depot's last quarter was quite impressive as the company's net sales and net earnings both increased with a 33% increase in earnings per share when compared to the same quarter last year.

The non-directional strategy that was used to trade Home Depot's earnings was the May 52.50/50 strangle and for more details please refer to the previous article with link provided above. If investors bought for the price recommended of 1.00 or below then an investor would have made $38 one a 1:1 ratio (one call bought for every put bought). If investors waited until May 17th then this trade would have produced a profit of $197 per strangle. One of my other reasons that was not discussed in my previous article for using a strangle on Home Depot is because when looking at a year to date chart investors will notice that Home Depot is looking to break out; with earnings being the catalyst that can drive Home Depot's shares higher.

When this trade was presented Home Depot was trading at a year to date high of $52.71 and with earnings right around the corner Home Depot's shares were poised to continue running higher. Unfortunately, May was a dull month for the markets and shares of Home Depot slid 7% in the month of May despite the upbeat forecast for Home Depot. Since May, Home Depot is once again at another year to date high and rather than place a bet that Home Depot could continue running higher, I would rather play both sides of the fence with Home Depot reporting earnings on August 14th using a non-directional options strategy.

Chart forThe Home Depot, Inc.

Trade Idea: Strangle

Buy August 18 55 Call = 0.60 (0.60 x 100 = $60)

Buy August 18 52.50 Put= 0.72 (0.72 x 100 = $72)

  • Upper Breakeven Point = Strike Price of Long Call + Net Premium Paid
  • Lower Breakeven Point = Strike Price of Long Put - Net Premium Paid

Breakeven Points: Call Side= $55+0.60=$55.60

Put Side= $52.50-0.72=$51.78

Total Cost = $132 (60 + 72 = $132) per one strangle

After trading Home Depot's earnings I wanted to trade Lowe's earnings since Lowe's is Home Depot's biggest competitor and has a similar business model. On May 21st Lowe's released their 1Q earnings that increased 14% on unusually warm temperatures that have helped contribute to consumers making spring/summer purchased earlier than expected. While sales were positive Lowe's cut their full year earnings outlook and shares of Lowe's responded by selling off by more than 10%

Besides Lowe's slightly lowering full year guidance by 0.02 cents from their February forecast Lowe's is still lagging behind rival Home Depot. Home Depot posted a 5.8% increase in same store sales for the last quarter compared to Lowe's 2.6% increase in same store sales which is somewhat disappointing for Lowe's. One factor to consider for both Lowe's and Home Depot is that both of these companies have benefited from a mild winter and were able to make a quick transition to getting ready for spring/summer earlier than expected. With the summer heat wave that has blanketed most of the Midwest investors may wonder how summer seasonal products are selling with record heat across the Midwest. With record high temperatures that has produced little rain consumers may not be buying grass seed, fertilizers, lawnmowers and other outdoor products that could impact both Lowe's and Home Depot earnings. However, this is only one of the many segments to both Home Depot and Lowe's businesses and weakness in one segment can be offset with gains in others (construction products, lumber and appliances for example). Lowe's has been lagging behind Home Depot for a while and Lowe's upcoming earnings on August 20th will tell if management is finally making key changes to catch up to Home Depot and here is how to trade Lowe's upcoming earnings using options.

Chart forLowe

Trade Idea: Strangle

Buy August 28 Call= 0.30 (0.30 x 100 = $30)

Buy August 26 Put= 0.35 (0.35 x 100 = $35)

  • Upper Breakeven Point = Strike Price of Long Call + Net Premium Paid
  • Lower Breakeven Point = Strike Price of Long Put - Net Premium Paid

Breakeven Points:

Call Side= 28+0.30= $28.30

Put Side= 26-0.35= $25.65

Total Cost = 0.65 (0.65x100=$65) per one strangle

In summary, investors have some time to set up their trades before earnings and I will be looking to trade both Home Depot and Lowe's earnings. At the time I am writing this article shares of Home Depot are trading at $53.71 and for the strangle to be profitable investors will need Home Depot to move at least a 3.5% up or down before August 18 (when August options expire). Lowe's is currently trading at $27.07 and for investors to be profitable Lowe's needs to move at least 5% before options expiration. These percentage movements may seem a lot in either direction for Home Depot or Lowe's upcoming earnings, but looking back at trading non-directional strategies in the past on Home Depot and Lowe's could be successful again.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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Tagged: , , Home Improvement Stores, Options
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