TAKEAWAYS
- To take advantage of Home Depot's stock price decline, try implementing the put vertical spread
- The put vertical spread can lower your risk while you capitalize on the downside move in HD
- By going out to the August expiration, you can open a put vertical for a relatively low price
America's largest home improvement store, Home Depot, Inc. (HD), has benefited from a long period of investor interest and traded at a premium valuation for several years. However, the recent environment of slowing consumer spending and higher interest rates has finally caught up with HD; the risks are to the downside, below $300.
After rallying toward its all-time highs just shy of $400, HD has pulled back below its key $350 and $335 support levels and is at risk of continuing lower. HD's relative performance recently reached a new 52-week low. This suggests further downside risks, with targets at the next support lower, just below $300.
FIGURE 1. DAILY CHART OF HOME DEPOT (HD). The price of HD stock has broken below a key support level and could see further downside.Chart source: StockCharts.com. For educational purposes.
Trading at 21x forward earnings, HD is still trading at a premium, given that analysts are only expecting Earnings-Per-Share (EPS) and Revenue to grow at low single-digit levels, while net margins sit below 10%. The reality is that with relatively thin margins and consumer spending further slowing down, HD will have a tougher time commanding the same type of premium valuation relative to the market.
Options are inexpensive now, so buying downside exposure is cheap, and can be done by going out to August and buying the $325/300 Put Vertical @ 6.50 debit. This entails buying a higher strike put and selling a lower strike one (see below).
- Buying the Aug $325 Puts @ $9.35 Debit
- Selling the Aug $300 Puts @ $2.85 Credit
FIGURE 2. EXAMPLE OF A PUT VERTICAL SPREAD OPTIONS TRADE FOR HD.
This would risk a total of $650 ($935 - $285) per contract if HD is above $325 at expiration, while potentially making nearly three times that of $1,850 per contract if HD is below $300 at expiration.
