Throughout the wild buoyancy of the real estate market during the new normal – a consequence of the COVID-19 pandemic – experts in the field have consistently urged prospective homebuyers to consider pulling the trigger now instead of waiting for the market to correct, an event which might only arrive after many years into the future. However, that future appears to be on the horizon.
Recently, Barchart.com’s screener for unusual options activity put a massive spotlight on KB Home (KBH), a popular homebuilding firm headquartered in Los Angeles, California. Essentially, traders are buying up put options, which generally feature negative implications as they rise in value when the underlying security dips in the equities market.
Nevertheless, many people within the real estate industry are putting on a brave face. For instance, Danielle Hale, chief economist at Realtor.com, told CNN Business that “Price growth is going to slow, but I expect prices to stay high. If home sellers can't get the price they want, they are likely to not put it on the market.”
However, the sudden lift in put options against KBH stock suggests that the two aforementioned developments cannot be true. If price growth is merely going to slow but nominally remain high, then it doesn’t make rational sense for homebuilding demand to slip so badly.
Sure, supply chain disruptions for key commodities exist but the equities sector is a forward-looking indicator. Professional traders are wagering on what could be, not what is. Therefore, the weight of bearishness in KBH stock is quite significant.
KBH Stock and the Granularity of the Bearish Bet
When the closing bell rang out on the July 12 session, the volume level for the $29 puts with an expiration date of Aug. 19, 2022 reached 11,699 contracts. The open interest reading was 196, thus leading to a volume-to-open-interest ratio of 59.69. Per Barchart.com’s screener, it was the most unusual options activity for the day.
At the time of this writing, there are 38 days till expiration. However, with a closing price of $30.39, KBH stock needs to decline by around 4.6% to be in the money. Considering that shares are down 29.5% on a year-to-date basis, this wager doesn’t seem outlandishly risky.
Interestingly, the bid-ask spread for the aforementioned puts is 3.5% as represented by the midpoint price ($1.42). Compared to many other high-profile transactions printing unusual options activities, the spread here is quite narrow.
First, this dynamic indicates higher liquidity for the trade; basically, more bulls and bears want to participate. Second, the market makers facilitating this transaction have greater confidence in placing this bet profitably. All other things being equal, market makers prefer providing narrower spreads to stay competitive against their peers. However, if a trade is fundamentally or technically outlandish, market makers will widen the spread to protect themselves.
Apparently, these facilitators do not see the need for excessive safety margin, which has negative implications for KBH stock while auguring well for prospective homebuyers.
Time for a Reality Check
Another interesting stat to consider is the put/call open interest ratio, which for KBH stock stands at 1.91. Generally speaking, a ratio above 1 – which denotes equal purchases of calls and puts – is considered bearish. However, since traders tend to buy more calls than puts organically, the threshold of bearishness usually begins above 0.7.
Therefore, at 1.91, KBH stock features incredible pessimism. Again, such an outlook is odd if housing demand is projected to be elevated against historical norms. What’s going on?
Namely, the real estate market needs a reality check. Evidence indicates that in major metropolitan areas in the U.S., households are paying 40% of their income to core living expenses such as rent or mortgage payments. That’s just not a sustainable circumstance.
Further, many (biased) real estate experts may not be paying attention to the concept of quality of buyer demographics. Similar to quality of earnings, just because the number of adults increased in the U.S. does not necessarily mean they are all qualified buyers.
Indeed, the worsening wealth gap in the U.S. between the social elites and the middle class suggests that there are fewer qualified buyers than in years past. Therefore, the housing shortage dilemma is not quite the threat that some real estate brokers and agents make it out to be, which also indirectly adds pressure to KBH stock.
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