The LEAPS Option Trader
105 W. Monument Street
Baltimore, MD 21201
Thursday, August 12, 2004
Email – #193
** Revisiting Toll Brothers
There is little doubt that the economy is slowing. Our latest winners have been on the short side and our losses have been in technology. The mood of the country is beginning to turn and the markets may continue their decline. Upcoming consumer confidence numbers will be lower, in my opinion, reflecting the higher oil prices and the continued pressure on consumers at all levels.
The housing boom in the U.S. may seem strong right now, but that is peaking as noted by the decreasing rate of growth in the economy. The last remaining factor is how people feel about the future. I believe that people are not comfortable with the current pace of growth, the slowdown in job growth, rising rates, rising oil, an overheated real estate market and a falling stock market. Throw in the usual geo-political tensions and continued threats to the U.S. from terrorists and you have a combination of factors that could lead to a spending meltdown.
We shorted Toll Brothers (NYSE: TOL) unsuccessfully a few months ago. We may have been early, but we still have the opportunity to do so again. I am choosing Toll, not because it is a bad company (just like Ultra was not a bad company – and still provided significant profits). I am recommending the Toll short because it is a highflier in an industry at risk. The company just reported its outlook of a strong quarter and a good backlog ahead. However, if one reads closely, the good backlog is made up of NON-BINDING contracts – ones that consumers can walk away from.
The latest slowdown in the economy has led to rates on the long end falling. That may be good news for now, but what happens when consumers, even those who buy Toll’s houses, experience a triple whammy – an economic slowdown, reduced consumer confidence and a slowdown in the rate of increase in home prices… or even a decline.
In many areas of the country the average time to sell existing houses is increasing – not significantly yet, but still beginning to show early signs of a top. From my investigation and research, most of the overheating in housing today is being caused by the easy- money speculators buying houses for short-term investments and trying to flip them quickly, causing large price increases in certain markets that do not bear any resemblance to understandable values.
People are buying homes next to landfills for $600,000, spending over a million next to a railroad track – just for a view of water. These are not rational choices made for the long-term, but desperation fueled by the belief that there is potential for even garbage homes to increase in price.
Even here in Vancouver, where I am today, stories are rampant about banks loaning money to just about anyone for real estate, and people qualify for loans in one breath while secretly complaining they can barely afford the rent for their current residences. When the housing boom ends, it will not be pretty.
Buy the Toll Brothers January 2006 $35 put options (YKW-MG). These are currently trading at $4.10 on the offer on several exchanges. Do not pay more than $4.20. Just like in Ultra, we will use a HARD STOP. In this case that hard STOP is $2.10 – so our investment in this pick is $2.10.
Regards,
Karim Rahemtulla
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Bio:
Karim Rahemtulla is the former Investment Director of The Oxford Club. The editor of The Smart Options E-Report, The Income Trader – A Covered Call Strategy and The LEAPS Option Trader, Karim is also a regular contributor to The Oxford Club Communiqué. His highly successful trading systems use covered calls and LEAPS to boost returns on blue chip stocks, and during the bear markets of 2000 and 2001, his picks outperformed the major market averages. Educated in England, Canada and the U.S. and fluent in several languages, Karim travels the world to find the best investment opportunities for our members.
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