Market Overview
First, a couple housekeeping notes: With Santa coming in a few days, there will be no Cabot Profit Booster issue next Tuesday. Have a great holiday weekend!
Next, coming out of December expiration we have three stock positions (CCJ, MRO, GPS) that are uncovered by short calls. While I don’t think these stocks are likely to truly fall apart, because the market is so weak, today I am going to sell those stocks.
To execute these trades you need to:
Sell CCJ Stock
Sell MRO Stock
Sell GPS Stock.
Moving on … This week we are adding a covered call position in a recent earnings winner, though of note, because the market is weak, we are doing so by selling an in-the-money call in order to give our position room to the downside.
The Stock – D.R. Horton (DHI)
Why the Strength
We’re growth-oriented investors, but we’re also students of the market and relative strength, and we’re very intrigued with the action of homebuilding stocks and of D.R. Horton in particular, which is the largest homebuilder in the U.S., having a countrywide footprint that’s led to a continual gain in market share. (It accounted for about 6% of single-family new home sales in 2013, but that’s risen to around 12% so far in 2022.)
With mortgage rates having skyrocketed since the fall of 2021, business has begun to feel the effect; in the September quarter, sales (up 19%) and earnings (up 26%) did well, though forward-looking measures were worse, with new orders off 10% (in dollars) and backlog down 16%. Still, given the severity of the interest rate hikes (mortgage rates went from 2.5% to 7%), the quarter was actually better than feared. And now investors are looking ahead as long-term rates are actually falling—ironically, as the Fed tightens, bonds are turning bullish, with mortgage rates nosing below 6% in recent days.
There’s little doubt business is likely to suffer in the quarters to come—for the fiscal year ending next September, Wall Street sees Horton’s earnings off nearly 40%! But the bottom line here is that all of that appears to have already been discounted; the stock is trading at just 9x those earnings estimates, which could prove conservative—and a modest dividend yield (1.1%) and share buyback program (share count down 3.4% from a year ago, with more on the way) helps the cause, too. It’ll be news driven, but D.R. Horton seems like an interesting turnaround play.
Technical Analysis
DHI had a great run after the 2020 crash in two stages, first moving to new highs in August near 77, and after a multi-month rest, a push all the way to 107 in May 2021. That began the topping process, which then led to the bear market decline that took the stock down to 60 in June—but, despite all the Fed hikes and bad housing news since then, that was DHI’s bottom, with a higher low etched in October (near 66) and an emerging uptrend since then, with no desire to retreat even when the market has gotten hit. Stop – 76
The Covered Call Trade
Buy D.R. Horton (DHI) Stock at 87.5, Sell to Open January 85 Strike Calls (exp. 1/20/2023) for $5, or a Net Price of 82.5 or less
Static Return: $250 per covered call (3.03%)
Breakeven: 82.5
Covered Call Return (if assigned): $250 per covered call (3.03%)
Please note, the stock and options prices will be moving throughout the day, so these prices are simply an approximation of prices that you should be able to achieve.
However, the important component of this equation is that the stock price paid, minus the premium received via the call sale, equals the Net Price, or 82.5 or less. (In this case 87.5 minus 5 = 82.5. Or another example is you could pay 87 for the stock and sell the call for 4.50, which also equals 82.5)
For every 100 shares of stock you buy, you can sell 1 call. For every 200 shares of stock you buy, you can sell 2 calls. And so on …
Open Positions
If our stop is hit, I will send an alert giving detailed instructions on how to exit the trade. But don’t get too worried about setting the stop. I will manage that for you.
The next Cabot Profit Booster issue will be published on January 4, 2023.
