Monday, April 23, 2007
The last time S&A Short Report readers traded the housing sector, we rode it to gains of more than 200%.
And given last week's action in homebuilders, it's time to try it again.
Last July, housing stocks were caught up in a vicious nosedive. The sector was shrouded in bad news. Investor sentiment was horribly bearish. And the stocks could not catch a bid.
But where most investors saw problems, we saw opportunity: The stocks were cheap, the call options were cheap, and the sector had fallen so hard so fast that a bounce seemed inevitable.
So we bought call options on luxury homebuilder Toll Brothers (TOL).
Two days later, we sold half the position at a double. And we cashed out the balance of the trade two weeks later for a gain of 200%. The same setup that got us into the housing trade last July exists today.
Investors started off 2007 looking for a rebound in housing. We saw a few favorable numbers in new housing starts and housing permits. That pumped up investors' expectations. Many stocks in the sector gained 20%-25% in just the first few weeks of the year.
But the high hopes faded as fast as Don Imus' radio career.
The subprime-mortgage debacle, along with an inventory glut and a plague of canceled orders, has investors fleeing the sector once again.
And that gives us our opportunity.
Most of the major homebuilding stocks are just a fraction above last July's lows. The valuations are compelling. Investor sentiment is bearish. And the stocks are ripe for a bounce. But perhaps the most bullish signal for these stocks is what happened to the nation's largest homebuilder, D.R. Horton, last week…
On Thursday morning, D.R. Horton announced earnings well below expectations. Profits fell 85%, new orders fell by a third, and cancellations are at an all-time high. The stock opened lower initially, but only shed six cents on the day. On Friday, the stock gained 2%.
When a beaten-up stock rallies in the face of bad news, it's often a sign that the selling pressure is exhausted… and the slightest hint of buying interest can send stocks sharply higher. Fortunately, Short Report readers were ahead of the game. Our call options on D.R. Horton purchased last Wednesday have already gained 30%.
Given the compelling fundamental valuations and the eerie similarity to the setup last July, I see more gains to come in the homebuilders. In fact, this afternoon, I'm telling S&A Short Report subscribers about another trade on a housing-related stock. The setup is so compelling, we'll make money if the stock goes up, stays the same, or even drops a bit. It's as close to a "no-brainer" idea I've seen in quite a while.
Best regards and good trading,
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