The LEAPS Option Trader
105 W. Monument Street
Baltimore, MD 21201
Friday, July 15, 2005
#259
** A Last Shot at the Housing Bubble
Over the past few years I have learned that trying to call a top in a bubble is meaningless. I am usually early to the party. But, by using LEAPS, I can afford to be early to the party because I am risking less dollars and I have a lot of time on my side. The only kink is the use of a stop loss, which can have a short-term impact. Stop losses are important, but in some cases (like the pick today), they can cause more harm than good.
Without a doubt in my mind, there is a housing bubble in the U.S. I thought so last year, and the year before as well. The bubble outlasted me and we lost money on a Toll Brothers put LEAP – we actually made money on a Toll put leap a couple of years back… when there was no bubble.
There is only one telling statistic that tells me that we are in a bubble. That statistic is that the average worker cannot afford the average house in most cities in the country. Unless, he uses some type of synthetic mortgage that allows a nothing-down, no-interest (for a few months anyway) program that is being pushed whole hog by mortgage bankers.
How does someone in San Diego buy a home, with median home prices of a million dollars when the average household income for the area is less than $75,000? The answer is not so easy. But it is happening as investors, not owners, are engineering deals to finance expensive homes with the thought that the property can only increase in value AND will be flipped before the first mortgage payment is due. It will end, and it will end badly.
You have heard often that homes don’t fall as fast or far as stocks in a correction. This is true, unless the bubble is so big that there is no choice but to walk away and watch prices crash. In the early ’90s, the Northeast U.S. saw a correction of 15% to 25% in prices. Last month, parts of Boston saw 10% to 12% decreases in prices year over year. A correction will happen – the question is when and how severe it will be.
Time and again, I have said that the magnitude is not as important as the trend when investing with LEAPS. We don’t need a 30% crash in home prices to make money; just a couple of months of negative data on home price growth should do it. And in this overextended market, I think that will happen.
But, because I cannot predict when it will happen, I am comfortable owning a put option on one of the most volatile companies in the sector – with MORE THAN 900 DAYS to be right. The option is way out of the money, but as I recall with a past put option I recommended on Tiffanys – the strike price is not as important as the direction (as long as the shares move in that direction) within 12 months of expiration. In this case, we have almost three years.
As for picking a company in the sector to short – it really does not matter much. The group acts in tandem – up together and down together. I looked for the one that would offer me the cheapest entry point, the most volatility and the longest term. The company I came up with is D.R. Horton (NYSE: DHI), which has operations in most of the “bubble” areas in the country.
Here’s what to do:
Here’s how to play the collapse in housing prices with 2.5 years for it to happen. Buy the D.R. Horton (NYSE: DHI) January 2008, $25 PUT LEAPS (YRI ME). These are currently trading at $2.90 on the offer. These options are not especially liquid, so do not pay more than $3. We will not use a stop loss with this pick. I will monitor it carefully and advise a sell if necessary. Our target is 50% plus in profits within 12 months.
Regards,
Karim Rahemtulla
Current Portfolio:
Company / Symbol: D.R. Horton
Option / Symbol: Jan. 08 $25 put (YRI-ME)
Date Purchased: New
Current Price: $2.90
Comment: Buy at $3 or better. No trailing stop.
Company / Symbol: Computer Associates
Option / Symbol: Jan. 07 $30 call (VCA-AF)
Date Purchased: New
Current Price: $3.60
Comment: Hold
Company / Symbol: Energy Select SPDR (AMEX: XLE)
Option / Symbol: Jan. 06 $42 put (WHA-MP)
Date Purchased: 6/2/05
Current Price: $1.55
Comment: Hold.
Company / Symbol: Doral Financial (NYSE: DRL)
Option / Symbol: Jan. 07 $20 call (OVL-AD)
Date Purchased: 5/6/05
Current Price: $1.95
Comment: Hold.
Company / Symbol: Comcast (Nasdaq: CMCSA)
Option / Symbol: Jan. 07 $35 call (VPK-AG)
Date Purchased: 2/16/05
Current Price: $2.20
Comment: Hold. Mental sell stop is $1.95.
Company / Symbol: General Electric (NYSE: GE)
Option / Symbol: Jan. 07 $40 call (VGE-AH)
Date Purchased: 1/4/04
Current Price: $1.35
Comment: Hold.
Company / Symbol: S&P 500 MITT (AMEX: MCP)
Date Purchased: 7/18/03
Current Price: $10.95
Comment: Buy under $10. No TS.
Bull & Bear Spreads
Company / Symbol: Lexar (Nasdaq: LEXR)
Option / Symbol: Jan. 07 $5 call (VRF-AA)
Date Purchased: 3/29/05
Current Price: $1.65
Comment: Hold
Company / Symbol: Lexar (Nasdaq: LEXR)
Option / Symbol: Sell Jan. 07 $7.50 call (VRF-AU)
Date Sold: 3/29/05
Current Price: $1.00
Comment: Hold. Sold call against Jan. 07 $5 position.
Company / Symbol: Energy Select SPDR (AMEX: XLE)
Option / Symbol: Jan. 07 $39 put (ORJ-MM)
Date Purchased: 3/1/05
Current Price: $1.95
Comment: Hold.
Company / Symbol: Energy Select SPDR (AMEX: XLE)
Option / Symbol: Sell Jan. 07 $37 put (ORJ-MK)
Date Sold: 3/30/05
Current Price: $1.45
Comment: Hold. Sold put against Jan. 07 $39 position.
Company / Symbol: Intel (Nasdaq: INTC)
Option / Symbol: Jan. 06 $22.50 call (NQ-AX)
Date Purchased: 10/19/04
Current Price: $5.90
Comment: Hold.
Company / Symbol: Intel (Nasdaq: INTC)
Option / Symbol: Sell Jan. 06 $25.00 call (INQ-AE)
Date Sold: 11/2/04
Current Price: $3.80
Comment: Hold. Sold call against Jan. 06 $22.50 position.
Company / Symbol: Interactive Corp. (Nasdaq: IACI)
Option / Symbol: Jan. 07 $25 call (VSW-AE)
Date Purchased: 9/14/04
Current Price: $3.90
Comment: Hold. No TS.
Company / Symbol: Interactive Corp. (Nasdaq: IACI)
Option / Symbol: Sell Jan. 07 $30 call (VSW-AF)
Date Sold: 12/10/04
Current Price: $1.75
Comment: Hold. Sold call against Jan 07 $25 position.
Company / Symbol: Nokia (NYSE: NOK)
Option / Symbol: Jan. 06 $22.50 call (NAY-AX)
Date Purchased: 8/29/03
Current Price: $0.15
Comment: Hold. No TS.
Company / Symbol: Nokia (NYSE: NOK)
Option / Symbol: Sell Jan. 06 $30 call (NAY-AF)
Date Sold: 2/9/04
Current Price: $0.05
Comment: Hold. Sold call against Jan. 06 $22.50 position.
Company / Symbol: Chesapeake Energy (NYSE: CHK)
Option / Symbol: Jan. 06 $12.50 call (CHK-AV)
Date Purchased: 7/28/03
Current Price: $13.30
Comment: Hold. No TS.
Company / Symbol: Chesapeake Energy (NYSE: CHK)
Option / Symbol: Sold Jan. 06 $15 call (CHK-AC)
Date Sold: 11/6/03
Current Price: $9.90
Comment: Hold. Sold call against Jan. 06 $12.50 position.
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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