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Morning Update

Yesterday one of the worst performing sectors was the homebuilders. The SPDR Homebuilders ETF, XHB, sold off 1.5% to close at its 50-day moving average. The ETF saw heavy option volume yesterday, most of which were puts. Over 8 times the average daily put volume traded and the put/call ratio was 12.8. The biggest trade of the day was the purchase of 21,000 Jan. 24/22 put spreads for $0.42 with XHB trading at 25.56. This is a bearish trade that profits if XHB is below 23.58 at January expiration. This would require a 7.7% decline over the next 67 days. This spread will realize its full value of $2.00 if XHB is below 22 at expiration, which will return a profit of $1.58 or a 376% return on risk. However, if XHB is above 24 at expiration this spread will be worthless.

Data suggests that the US housing market has bottomed, so why all the bearishness? Yesterday a component of the XHB, DR Horton Inc (DHI), reported earnings that beat EPS forecasts but missed on revenue. And last week Zillow, an online realtor, guided below what the street was expecting for Q4. This comes in contrast to housing data and suggests that momentum may be waning for the homebuilding sector. XHB is up 45.6% year to date, so these earnings and guidance misses are likely to cause some profit taking, especially ahead of the uncertainty surrounding the fiscal cliff.

This option trader’s spread targets a move to 22 for the XHB, which is currently the ETF’s 200-day moving average. A test of the 200-day is likely to be determined by the guidance the rest of XHB’s components deliver. Home Depot, XHB’s largest component, reported this morning with a beat and guided up, which is likely to lift the homebuilding sector after yesterday decline. If you want to get bearish exposure to the sector, consider today’s strength an opportunity. But use spreads like this to keep risk fixed and reward/risk ratios high in the event the 50-day moving average holds as support for the XHB

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