Home Depot Inc (NYSE:HD) reported earnings this morning and so far investors are not impressed. The stock is falling early but is off the lows of the knee-jerk reaction. In a rising stock market, this is an opportunity to go long.
Based on the options open interest, this downside move was predictable and I discuss that in detail later. Now that the earnings event is out of the way, I can set a trade without the risk of scheduled headline looming for three months to come.
HD stock came into the earnings report up only 1.5% but it has outperformed the S&P 500, up 20% in a year, so the bulls had momentum coming the headline. Moreover, the stock was tracing out a breakout pattern with $196 as a potential target. This dip may put a wrinkle in that rally, but rarely do short-term dips on earnings affect the long-term trajectory of a quality stock.
This morning, management reported mixed results. They beat the bottom line but missed on the revenues. Almost never will Wall Street forgive a retail company for missing the comparable sales. Moreover, they guided below expectations, and these days that is a big no-no. Nevertheless, a 2% dip is minimal given the infraction. This speaks to the quality of the company.
Fundamentally, the stock is not screaming cheap but at a 26 price-to-earnings ratio it’s not bloated either. So if I have the chance to buy it at a discount even below today’s prices, it is not going to be a financial mistake.
Rates are rising, and that could put downside pressure on home purchase, which could play into HD’s hand. Fewer home sales could mean that more people will renovate their existing abodes and HD is their default supplier.
I personally prefer shopping at Lowe’s Companies, Inc. (NYSE:LOW) but that’s because it’s closer to my house and usually less crowded. HD has the better selection, and that’s where more professionals go for their supplies.
Long term, HD management has been brilliantly executing on their plans and that’s not likely to change. So as long as we have cheap money circulating in the U.S. from lower corporate taxes and higher wages then HD will do well.
In spite of my optimism, I am not here to chase Home Depot stock rallies. I was lucky enough to have some profits in pocket already so this is a rinse and repeat setup for me. I could split my risk between this and a LOW trade if was already long it.
Today I sell downside risk into what others fear. While we are near all-time highs in stock markets, I find it much easier to bet on downside support holding than chasing upside hopium. This way I leave room for error just in case the tariff war headlines rekindle.
Click here for a detailed analysis on how I predicted the price action on the headline this week — I came within 40 cents of the actual whoosh lower — and to get an ongoing free copy of my weekly newsletters.
HD Stock Trade Ideas
The Trade: Sell the HD Aug $165 put for $1.60. Here I have a 85% theoretical chance of success. Otherwise and if the price falls below that level then I would suffer losses below $163.40.
Those who want to mitigate the risk that comes with selling naked puts can sell spreads instead.
The Alternate Trade: Sell the HD Aug $165/$160 credit put spread. The spread has the same odds but would deliver 15% yield on risk. Neither trade requires a rally to profit. In fact the stock can fall an additional 14% and I could still retain maximum gains.
Nicolas Chahine is the managing director of SellSpreads.com. As of this writing, he did not hold a position in any of the aforementioned securities. You can follow him as @racernic on twitter and stocktwits.
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