The LEAPS Trader
105 W. Monument Street
Baltimore, MD 21201
Tuesday, September 26, 2006
Email – #340
** You Ain’t Seen Nothing Yet
If you are under the impression that the housing market is slowly falling through the floor, you are right. But the rate of speed with which housing prices will fall in 2007 will dwarf that of this year. There are several reasons…
First, there is an oversupply of homes on the market. Second, builders have not yet finished projects that were begun six months ago when all was rosy. Third, sellers still are wishing and hoping they can sell their houses to the “right” buyer next week. Just like the Nasdaq collapse earlier this decade, investors are prone to overly optimistic projected outcomes in their personal situation. But, the laws of supply and demand do not work that way. Equilibrium in prices will be found at some point, but that point is not nearly where we are today. We may not see a 70% crash in housing prices, but a fall of 20% to 40% from the highs in many areas WILL BE THE NORM, not the exception.
We shorted housing shares last year and this year with limited success. We were early. Is there room for more downside? Yes. But, why short a sector where prices have already fallen more than 50%? The downside is limited in this sector as prices reflect a massive slowdown in profits ahead.
Instead, I would rather focus on the areas that once wealthy consumers, and once wealthy home sellers, and their spouses like to spend that equity. The retail sector will suffer. Maybe not at the low end, but likely at the middle-to-high end. In this sector, my top choice for a decline in price is JW Nordstrom (NYSE: JWN).
Nordstrom is one of the best high-end retailers in the country. But, it also caters to a part of the population that will be most affected by the housing slowdown, the middle and upper-middle class who used their home equity piggy bank to a do a lot of shopping these past few years. So, we are going to look at Nordstrom as a proxy for high-end retailing. Shares of other high-end retailers like our perennial favorite short, Tiffany’s (NYSE: TIF), have already fallen off the cliff this year. Meanwhile, Nordstrom is trading at close to 52-week highs on good numbers reported last quarter. Still, that’s old news. We have a massive quarter coming up for Christmas sales, and that should tell us more about the state of the economy and the consumer than anything else.
Here’s What To Do:
We will take a 16 month LEAP on Nordstrom (NYSE: JWN), betting that the shares will fall 10% to 20% in the next six months, resulting in a 50% plus gain on the option. Buy the Nordstrom January 2008 $40 LEAP PUT (YJY MH.) The option is currently trading at $4.10. The shares are trading at $43.36. Do not pay more than $4.10 for this option. It is very liquid and there is no need to chase the price.
Good investing,
Karim Rahemtulla
