Options Update: Pulte Homes Put Sellers Bet on Long-Term Support

Just when the credit crisis and trouble with the financial sector had taken center stage on Wall Street, the housing sector reminded investors why they dare not forget about this troubled section of the market. Yesterday, the Commerce Department reported that housing starts dropped by 4.5% to their lowest level since the end of World War II. In the past year, housing starts have fallen 38%, and are down about 70% from early 2006. With operations in 51 markets and 26 states Pulte Homes
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finds itself at the center of this unrelenting maelstrom.

Wall Street analysts are decidedly bearish toward PHM, as Zacks.com reports that 7 of the 9 brokerage firms following the shares rate them a “hold” or worse. What’s more, opinions among the analyst community continue to worsen, as Citigroup cut its rating on PHM to “hold” from “buy” on November 3. With only 1 of the 9 analysts covering the shares rating them a “sell,” additional downgrades seem likely given the worsening situation for the housing sector.

Shifting Sentiment from Options Traders

Options traders have lagged the rest of the investing community in terms of pessimism toward PHM. The stock’s current Schaeffer’s put/call open interest ratio (SOIR) of 0.86 ranks below 73% of all those taken during the past year, indicating that the speculative group has been more optimistic toward the shares only 27% of the time in the past 52 weeks. However, data from the International Securities Exchange (ISE) and the Chicago Board Options Exchange (CBOE) suggests that a shift in this bullish stance may be underway. Specifically, puts bought to open on the ISE and the CBOE have outnumbered calls bought to open by a ratio of more than 4 to 1 during the prior 10 trading days. This ratio also ranks above 91% of all those taken during the past year, indicating a rising degree of skepticism toward PHM from the options crowd.

This trend toward PHM put options has taken an interesting twist in today’s trading, however. Looking at our Intraday Volume Explosion List, I noticed that more than 24,000 PHM puts have changed hands so far, outpacing the stock’s average daily put volume by more than 9.7 to 1. The most active contract is the December 7.50 put, which has seen more than 16,000 contracts trade on open interest of just 730. However, it was the fact that nearly all of this volume changed hands at the bid price that caught my eye today, as this potential put-selling activity runs in stark contrast to the swell in put buying reported by the ISE and the CBOE.

Pulte Homes option volume details

The Anatomy of a Pulte Homes Put Position

Digging into this put-buying activity, I noticed that 2 blocks of 500 and 14,500 contracts changed hands at 10:09 a.m. Eastern time on the same exchange – suggesting that they were part of a combined position. With the block crossing at the bid price of $0.95 and volume far exceeding open interest, this trade appears to be a rather large bet that PHM will hold above the 7.50 level by the time these options expire on December 19. Running with the put-selling theme, the total credit received for this trade arrives at $1,425,000 — ($0.95 * 100)*15,000 = $1,425,000. Remember that a put-sell trader keeps the premium received on the trade as long as the underlying shares remain above the sold strike through expiration, which, in this case, is December 19, 2008.

Getting Technical

From a technical perspective, the stock has dropped roughly 18% on a year-to-date basis, outperforming the S&P 500 Index’s (SPX) loss of more than 45% for the same time frame. Furthermore, the shares have bested their sector peers in the ISE Homebuilders Index (RUF) on a relative strength basis since late December 2007. As such, while housing stocks continue to be pummeled by selling pressure, PHM appears to be holding up better than the rest of the housing sector.

Weekly relative strength, Pulte Homes versus the ISE Homebuilders Index since December 2007

Zeroing in on a weekly chart for the security reveals that the stock has pulled back to key support near the 8 level. This region has helped buoy PHM since January. However, the stock continues to battle overhead resistance at its falling 10-week and 20-week moving averages. What’s more, these trendlines recently completed a bearish cross – a technical formation that often portends additional losses for the shares. Should selling pressure increase and push PHM below the 8 level, the next short-term backstop for the shares resides at the stock’s October lows in the 7 area.

Weekly chart of Pulte Homes since November 2007 with 10-week and 20-week moving averages

The Verdict?

PHM’s technical backdrop offers up some potentially stalwart support that could help keep a sold December 7.50 put out of the money, as the shares have not closed a week below the 8 level so far this year. That said, the unwinding optimism among options traders and the potential for downgrades from the analyst community add considerable risk to the aforementioned put-sell position. As such, bullish PHM investors will want to keep a close eye on the stock’s options activity, as well as key support at the 8 level. Keep in mind that an increase in put buying activity, or a breach of technical support could send the stock sharply lower.

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Copyright Schaeffer’s Investment Research. www.schaeffersresearch.com.