Friday, July 13, 2012

HD: Riding the sidewinder on Friday the 13th

Home Depot Inc. (HD) experienced a stunning 54% rise from October 2011 into May of this year, from $34.29 to a May 3 high of $52.88.

Then things got interesting. The big box home improvement retailer corrected down to $46.37 on May 21, rose to a new high of $53.28 on June 20, and from June has been ensnared in a sideways trend running from about $51 to $53.

It is now trading at $52, the midpoint of the sidewinder. In the very near term, the price hit the floor of the range on Thursday, and today rose to a higher high -- a very short-term uptrend.

Headquartered in Atlanta, Georgia, Home Depot operates 2,252 stores in the United States and its territories, as well as Canada, China and Mexico. It identifies three segements of customers: the do-it-yourself crowd, the do-it-for-me set, and professionals who buy supplies for their contracting businesses.

As an options trader, I'm a fan of sideways trends. Riding a sidewinder can mean profit just as readily as an directional trend, and sometimes with greater certainty. This is an advantage that stock traders don't enjoy.

HD's price is at a level well below the sidewinder ceiling, yet not so low as to be in danger of crashing through the floor. A rise to the ceiling, even absent a breakout, would be a 2% gain, and a drop to the floor, absent a breakout, would be similar. So just based on support and resistance, the risk/reward ratio is 1:1, excellent odds in my book.

HD is also one of the few big stocks that can be traded without smashing immediately into earnings.  The company publishes on Aug. 14, giving room to to do an August options play, closing it Monday or Tuesday (Aug. 12/13) in the last week of trading prior to expiration.

My trading rules requires new positions be opened at least a month before an earnings announcement or entered into with the commitment to sell before the announcement.

Home Depot reports return on equity if 23% -- growth stock territory -- with a higher level of long-term debt than I like, at 60% of equity. It's not a crippling debt level, but I get nervous over 30%.

Annual earnings crashed in 2008 but have gained steadily since then. In the company's 2011 fiscal year, which ended Jan. 31, 2012, annual earnings exceeded the  pre-crash 2007 level for the first time.

The company's best quarter is the 2nd, covering spring and summer, when repair and construction work peak. The 2nd quarter earnings rose in 2011 over the year-ago quarter. The past nine quarters have all been profitable and showed upside earnings surprises.

Institutions own 72% of shares, and the price is near parity with the pace of business. It takes $1.11 in shares to control a dollar in sales.

My analyst enthusiasm index stands at 26%, up from 21% a month earlier. The index gives positive weight to strong buy recommendations, negative to holds, sells and strong sells, and ignores simple buy recommendations.

HD on average trades 9.2 million shares a day, a level of liquidity that supports an excellent selection of option strike prices with high open interest and narrow bid/ask spreads.

Call options are active, with volume 66% above the average of the last five days. Puts are less active, trading 22% below the average volume.

Implied volatility stands at 22%, about midway in the six-month range, and has been moving sideways for most of June. Options are pricing in confidence that 68.2% of trades will fall between $48.85 and $55.43 during the next month, for a maximum gain or loss of 6%.

The stock is trading in the upper portion of the five-day fair trade range, which encompasses 68.2% of trades surrounding the most-traded price, $51.99. The range runs from $51.58 to $52.32.

Home Depot next publishes earnings on Aug. 14. The stock goes ex-dividend in late August for a quarterly payout yielding 2.23% annualized.

Decision for my account: I like the chart, the financials, the options grid -- actually, there's nothing I dislike about this stock.

Despite the evil omens of Friday the 13th, I've opened a position today, structuring the trade as a bull put spread expiring Aug. 17, short the $50 put and long the $47 put. The position has a 15% potential profit, a risk/reward ratio of a bit better than 7:1, and is profitable at expiration down to a stock price of $49.60, well below the floor of the sideways trend.

Normally with options, I close the Monday or Tuesday of expiration week, which leaves room to get out before Wednesday's earnings report from HD.

Tim Bovee, Private Trader tracks the analysis and trades of a private trader for his own accounts. Nothing in this blog constitutes a recommendation to buy or sell stocks, options or any other financial instrument. The only purpose of this blog is to provide education and entertainment.
No trader is ever 100 percent successful in his or her trades. Trading in the stock and option markets is risky and uncertain. Each trader must make trading decision decisions for his or her own account, and take responsibility for the consequences.

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