A winning bet if homebuilder shares continue to weaken amid high interest rates
In late May, I published my bearish thesis on homebuilders and put forward a trade for DR Horton (DHI). Since then, homebuilders have continued to underperform the S&P 500 and as the 10-year yield continues to climb back to 4.5%. I believe there is more downside to come and now is another opportunity to take another bearish trade on DHI. In my original thesis, I stated that DHI had been trading in a range of $140 to $160 for the past 6 months and was at risk of falling below the $140 support level. Just earlier this week, the $140 support level was broken and we can now confirm a new downtrend. Furthermore, the relative performance of DHI relative to the market signals that further downside could be possible after breaking this key support level. Our downside target is now $125, the previous support level from before it rose into a $140-$160 trading range. DHI is currently trading at 8.8 times forward earnings, slightly below historical averages but with limited upside. Analysts currently expect DHI to grow EPS by just 4% and revenue by 6%, but with the 10-year yield approaching 4.5%, home starts and purchases continue to be impacted this year. With low implied volatility, DHI options are somewhat expensive. In keeping with our bearish outlook on DHI, I am using an August expiration and buying a $140/$125 vertical put with a $6.25 discount. This involves: Buying the August $140 put at $8.55 Selling the August $125 put at $2.30 Using a vertical put spread allows us to offset the cost of buying a straight put by limiting the downside. The total risk on this trade would be $625 per contract if the DHI is above $140 at expiration. The maximum profit would be $875 per contract if the DHI is below $125 at expiration. This strategy offers a favorable risk/reward ratio, with potential profit if the DHI continues to decline in line with our bearish fundamental and technical thesis. DISCLOSURE: (Bearish position on DHI) All opinions expressed by CNBC Pro contributors are solely their own and do not reflect the opinions of CNBC, NBC UNIVERSAL, their parent companies or their affiliates and may have been previously disseminated by them on television, radio, the internet or other media. THE ABOVE CONTENT IS SUBJECT TO OUR TERMS AND CONDITIONS AND PRIVACY POLICY. THIS CONTENT IS PROVIDED FOR INFORMATIONAL PURPOSES ONLY AND IS NOT INTENDED TO BE FINANCIAL, INVESTMENT, TAX OR LEGAL ADVICE OR A RECOMMENDATION TO PURCHASE ANY SECURITIES OR OTHER FINANCIAL ASSETS. THE CONTENT IS GENERAL IN NATURE AND DOES NOT REFLECT ANY INDIVIDUAL’S UNIQUE PERSONAL CIRCUMSTANCES. THE ABOVE CONTENT MAY NOT BE SUITABLE FOR YOUR PARTICULAR CIRCUMSTANCES. BEFORE MAKING ANY FINANCIAL DECISION, YOU SHOULD CONSIDER SEEKING ADVICE FROM YOUR OWN FINANCIAL OR INVESTMENT ADVISOR. Click here to view full disclaimer.
