For Whom the Bear Tolls

August 29 2022

For Whom the Bear Tolls

This is not a great time to be a homebuilder. The housing boom is over by most accounts. Consumer confidence in the housing market dropped to its lowest point since 2011. Sales of new homes plunged to a 6-1/2-year low in July. The Fed is not letting up on its interest-rate crusade. Do I need to go on?

Toll Brothers (TOL) echoed this sentiment in its recent earnings report. Although net income rose sharply in the third quarter and beat the analyst consensus estimate, revenue came up a bit short. More importantly, the homebuilder expects to deliver about 1,000 fewer units in fiscal 2022 than previously estimated.

TOL didn’t do much after earnings this week. In fact, it hasn’t done much for the past several months. The stock has been trading sideways for five months, with the top of the range around the $50 level. The fact that the shares couldn’t gain ground when housing was hot and interest rates low does not bode well for the future. Thus, we are going with a bearish call spread with the short call at the top of this trading range.

If you agree that TOL will continue sideways at best and lower at worst, consider the following trade that relies on the stock staying below $50 (blue line) through expiration in six weeks:

Buy to Open the TOL 7Oct 52 call (TOL221007C52)
Sell to Open the TOL 7Oct 50 call (TOL221007C50) for a credit of $0.45 (selling a vertical)

This credit is $0.02 less than the mid-point price of the spread at Friday’s $46.12 close. Unless TOL falls quickly, you should be able to get close to that price.

The commission on this trade should be no more than $1.30 per spread. Each spread would then yield $43.70. This trade reduces your buying power by $200, making your net investment $156.30 per spread ($200 – $43.70). If TOL closes below $50 on October 7, both options will expire worthless and your return on the spread would be 28% ($43.70/$156.30).