It is another beautiful week as we consider the options of players in the U.S housing market with special interests in stock and options of home improvement retailers. We will start with the options of The Home Depot, Inc. (NYSE:HD), a behemoth with a market capitalization of $110.95B. Home Depot with its full-service, warehouse-style stores sells an assortment of building materials, home improvement and lawn and garden products and provides a number of services.
I wrote a post about Home Depot for Daily Option Alerts in February in which I opined that I am testing the company’s future profitability with a May 2014 $85 price target. I set the $85 price target for May given the fact that Home Depot was set to release its Q1 2014 results on May 20 and I was hopeful that Home Depot will surprise in its first quarter after the harsh winter had slowed sales in the fourth quarter of 2013.
May has come and gone and Home Depot has released the first quarter results; yet, the stock failed to reach my $85 price target. The first quarter results were sturdy (highlights below) but the macroeconomic situations surrounding the U.S housing market does not provide much optimism going forward.
Highlights of First Quarter Results
- The company reported earnings of $0.96 per share to mark a 15.7% increase over the earnings of $0.83 per share that was reported in the same period last year. However, the earnings is short of the Zacks consensus estimate of $0.99 per share
- Net Sales increased by 2.9% to $19.6B from $19.1B that was reported in the same quarter last year. However, net sales was short of the Zacks Consensus Estimate of $19.97B.
- Gross profit increased by 3.1% to $6.8B from $6.6B in the same quarter last year
- Operating profit increased by 8.7% to $2.3B from $2.1 million in the same period last year
Reasons to Sell
- Macroeconomic Headwinds
The U.S job situation is recording improvements as the unemployment rate falls marginally and jobless claims reduce. However, the general downsizing and restructuring initiatives happening across board is leading to heavy job losses and reduced access to credit. Interestingly, the slow-paced increase in consumer spending shows that consumer discretionary income is practically stagnant; hence, Home Depot’s sales are not likely to increase at a significant pace going forward.
- Drop in Consumer Spending Leads to Drop in Home Depot Sales
The chart above plots the revenue and share price of Home Depot during the recession and the following years. You will see the steep plummeting of Home Depot’s fall in revenue and share price during the recession. The share price fell as low as $20 while the revenue was down to around $65B. Home Depot by nature remains a cyclical company that is dependent on the housing market for revenue and growth.
How to Trade HD Options
The growth in revenue and share price seems to be nearing a peak; hence, it might not be smart to remain bullish on this company as the current bullish cycle crests. Writing covered calls or buying put options are the smartest ways to make a play on the options of Home Depot. You can write covered calls with the $100 strike price against January 2015 expiration. I foresee shares of Home Depot falling to the early 70s in the next six months and I recommend buying the HD Jan 2015 77.500 put (HD150117P00077500).
— Daily Option Alerts