Options Update: Lennar Sees Spike in Put Volume Ahead of Earnings
Investors in the housing sector have yet to decide whether the recent government intervention in the market is a blessing or a curse for the group.
On Friday, the Select Sector SPDR S&P Homebuilders Index jumped nearly 5%, but the exchange-traded fund has plunged more than 6% in today’s trading as the market digests the latest proposal for $700 billion in aid to the struggling financial system.
Amid this tumult, Lennar
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PowerRating) has the unenviable task of reporting its third-quarter earnings figures.
Ahead of the open tomorrow morning, LEN is expected to post a third-quarter loss of 52 cents per share. However, even this loss would be a vast improvement over last year’s loss of $3.25 per share. Historically, the earnings confessional has not been kind to LEN, as the company has missed expectations in 2 of the past 4 reporting periods by an average of 114%.
Options players appear to be betting on a continuation of LEN’s poor fundamental performance, as the group is piling into puts ahead of the event. Some 2,095 puts have traded so far today, outpacing the stock’s average daily put volume by more than 5 to 1 and placing LEN on today’s Intraday Volume Explosion List. The majority of this volume has changed hands on LEN’s Novmeber 15 put, catching my eye this afternoon.
Glancing over LEN’s November 15 put volume today, I noticed a sizeable block of 473 contracts that traded at the ask price of $2.15. I’ll be using these 473 contracts for today’s put-buying example. I should note, however, that open interest at this back-month option totals a whopping 25,702 contracts. As such, today’s volume could be the closure of existing positions.
The Anatomy of a LEN Put Position
Diving into today’s put-buying example, the hypothetical trader purchased 473 LEN November 15 puts for $2.15, or a total outlay of $101,695 — ($2.15 * 100)*473 = $101,695. For this trade to reach breakeven, LEN would need to fall about 12% (in addition to today’s 13% plunge) to $12.85 per share. We arrive at this figure by subtracting the cost of the option ($2.15) from the strike of the purchased 15 put ($15 – $2.15 = $12.85). The total loss for this position is limited to the initial investment of $101,695.
Trading options near an event, such as earnings, is always risky. The event can provide the volatility needed for an extremely profitable trade, but the position can move against you just as quickly. LEN has been particularly volatile near its earnings releases, as evidenced by its Schaeffer’s Volatility Index (SVI) of 0.93. This reading is just shy of its recent annual high of 1.07 set on Thursday last week. As such, the stock’s options are pricing in a sizeable move, thus making LEN options relatively expensive at the moment. Before we pass judgment, however, let’s see if the stock’s sentiment or technical backdrops provides any drivers or roadblocks that could affect the trade.
Getting Technical
Despite the poor performance of homebuilders this year, LEN’s technical backdrop is not quite as dismal as one might expect. The shares are sitting on a loss of 6.4% for the year, but have rallied more than 56% since setting a 52-week low of $9.33 per share on July 15. The shares maintain the support of their 10-day and 20-day moving averages, while additional support lies just below the stock at its 20-week moving average in the 13.90 area. Both of these factors could work against a LEN put position in the event of a mediocre-to-positive reaction to the company’s earnings. However, the 14.50-14 region is key support for the shares, and a knee-jerk reaction to a poor report could quickly place the stock below these support levels, thus exacerbating any selling pressure.
The Sentiment Drivers
The stock’s sentiment backdrop offers several potential drivers that could spoil a LEN November 15 put. First, short interest accounts for more than 28% of the stock’s total float. A positive reaction to earnings could spook the weaker hands, thus creating a short-squeeze situation that could exacerbate LEN’s rally.
Meanwhile, Wall Street analysts are heavily bearish on LEN. Zacks.com reports that 5 of the 7 analysts following the shares still rate them a “hold.” Any upgrades from this bearish bunch could also provide positive price action for the shares. However, the impact could be minimal, as Raymond James upgraded LEN to “outperform” this morning, and the stock has responded by plunging nearly 13%.
The Verdict?
While I am not adverse to trading options ahead of events such as earnings, there are too many variables that could effect a LEN put trade at the moment. Outside of the earnings report is the pending $700 billion bailout of the financial sector by the U.S. government, as well as the potential for a move in the Federal Reserves key interest rate at the October meeting of the Federal Open Market Committee. If you have the stomach for such a trade, a November LEN 15 put could be very profitable, but the extenuating circumstances surrounding the homebuilding sector and the stock’s bearish sentiment backdrop could make this trade quite a rough ride.
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Copyright Schaeffer’s Investment Research. www.schaeffersresearch.com.