- Unusual options activity presents a dour picture for Home Depot.
- Market makers see little chance of upside, though this dynamic bolsters the contrarian thesis in HD stock.
- While terribly risky, going against the grain can present a significant upside opportunity.
An unintended and ironic consequence of the Federal Reserve’s (and Washington policymakers’) efforts to save the economy from the negative implications of the COVID-19 pandemic was the meteoric housing boom. Suddenly, home prices were well outpacing wage growth, creating a bidding frenzy among panicked consumers who felt the American Dream slipping away.
While making what amounts to be the largest transaction for most people during an economic crisis isn’t especially smart, the Fed’s extremely dovish monetary policies saw benchmark interest rates dive into subterranean territory. With borrowing costs substantially down from already-low levels, those who had the means to buy real estate benefitted handsomely. Unfortunately, this dynamic exacerbated wealth disparities, a matter I discussed on CGTN America while representing Barchart.com.
Now, the tables are turning on the housing market, which bodes poorly for companies that earlier benefitted from the boon like Home Depot (HD). Just consider some of the below headlines:
- On May 20, Redfin (RDFN) reported that historic housing shortages have shown signs of letting up as home sales decline.
- On June 10, Redfin also reported that luxury-home sales sank nearly 18% on a year-over-year basis during the three months ending April 30.
- On June 15, the Canadian Real Estate Association stated that its housing market in May slipped 22% from last year.
- On June 21, another Redfin report indicated that more than 40% of home sellers are dropping their prices in Salt Lake City, Boise and other pandemic hot spots.
It’s no wonder, then, that bearish unusual options activity targeted Home Depot. Nevertheless, short traders might be in for an unpleasant surprise.
The Bear Trade on HD Stock Might Be Too Easy
When the closing bell rang out on July 1, Home Depot emerged as a potential loser. In the derivatives market, traders singled out HD stock for further downside, buying a large number of $210 puts with an expiration date of Aug. 19, 2022. Volume was 23,086 contracts against an open interest reading of 798.
Even more interesting was the bid-ask spread, which was 3.6% when represented as a percentage of the midpoint price ($1.12). Earlier, I mentioned that General Motors (GM) was also the subject of unusual options activity, in this case for calls. However, its transaction featured a spread of 15%, which is rather large.
For GM, the wide spread indicates lower liquidity and lower confidence among market makers to execute the underlying trade at a desired price. On the other hand, the bearish narrative for HD stock features the opposite circumstance. A narrower spread indicates higher liquidity for the trade, along with greater confidence that the market maker can pin down the transaction profitably.
However, the bearish thesis for HD stock might not be a slam dunk. With fewer than 50 days to expiration, the near-term momentum for Home Depot is not favoring the pessimists:
- Trailing six-month performance: -32.4%
- Trailing one-month performance: -8.2%
- Trailing one-week performance: -1.5%
- Trailing 24-hour performance (July 1): +1.8%
With volatility slowing down, a possibility exists that HD stock could move against the implications of the underlying puts, putting a hurting on negative speculators.
Why the Bulls are Optimistic
To be fair, those who see HD stock declining may have the better data. In particular, existing home sales as provided by the National Association of Realtors show a 9.6% increase in sales between May 2021 and January 2022. However, from January to May, this stat declined by 16.6%.
If you take a look at the longer-term chart for HD stock, you’ll notice that the ebb and flow of the security largely corresponds with existing home sales. As mentioned near the top, with home sales declining in North America, it seems like a solid bet that Home Depot will continue following suit.
Nevertheless, it’s important to realize that HD stock isn’t just tied to the housing market. As an essential business, Home Depot provided a much-needed societal service, staying open late into the evening during the worst of the COVID-19 pandemic to help connect consumers with critical products. You can find many local stories about Home Depot weathering storms (literally) to help their customers.
However, it’s the same economic crisis that’s putting HD stock under pressure that can eventually become Home Depot’s saving grace. During the first year of the pandemic, the Joint Center for Housing Studies of Harvard University noted that do-it-yourself (DIY) home improvements surged, boding well for Home Depot.
To be fair, the researchers of the study believe that DIY sentiment will not continue longer term. I disagree. With the purchasing power of the U.S. dollar declining nearly 12% from January 2020 to May 2022, consumers will be desperate to save money. DIY projects do exactly that.
Still a Risky Proposition
The above analysis isn’t to say that going bullishly contrarian on HD stock is the wisest move available. Certainly, if the housing market weakens further, this would pose problems for Home Depot. And we haven’t discussed the possibility of more mass layoffs, which could also impose a wrinkle (to say the least) on any bullish market activity.
However, the main point is that the narrow-spread HD puts are no slam dunk. Even an irrational dead-cat bounce can implode this position. Moreover, the fundamental narrative isn’t wholly on the side of Home Depot bears.
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