by John Jagerson | November 6, 2013 6:57 am
Most home buyers are only superficially aware of the title insurance side of their home-buying experience. However, typically both the mortgage lender and the buyer will get a title insurance policy as part of the closing process. As you can imagine, title insurance company profits and revenue tends to follow the ebb and flow of the real estate market as a whole. However, possibly because the title insurance industry is less followed, there’s some lag time after a break lower or higher in the real estate indexes. This can present bullish and bearish short-term opportunities.
A contrarian bearish opportunity has emerged on Fidelity National Financial (FNF) that should be good for short term profits. This big title insurance company isn’t fundamentally unsound, but the recent run looks extremely overextended as their relative price performance has reached short-term extremes.
This could be an interesting opportunity for traders who want to own long puts or an outright short position as we expect the short term price target to be reached within the next few weeks at the most. The technical analysis for this trade is based on the relative performance extreme FNF has reached versus housing related indexes. This has happened before and is usually a good sign that traders are preparing to take profits.
In the next chart you can see FNF compared to the SPDR S&P Homebuilders ETF (XHB) with a relative performance indicator. The uptrend in the indicator means that FNF has been outperforming XHB until just the last two days. As you can see, this level has been a reliable trigger for short sellers or profit-takers over the last year or so. This time around, however, we expect the selling to be more extreme as yields continue to rise.
You will note that although these signals have been reliable in the past, some of the selling has been short-lived. This is a trade where it may be best to set some staging points to add to a position or even leg into a spread. If selling does not accelerate as we expect at support ($26.65) and the stock begins to consolidate we recommend an exit. However a break of that level is more likely to send the stock lower as we saw in June of this year.
In the right situation a long vertical put-option spread may actually be very productive — especially if the spread can be created one leg at a time.
Recommendation: Buy long puts at current prices in favor of an expected drop to $26.65 per share. Currently the at-the-money FNF December $27 puts are priced at 70 cents per share, and a drop to $26.65 in the short term should push those puts to $1.00-$1.10 per share.
Spread Trade: If the put option works out, that’s a decent gain on its own, but a spread trader may decide at that point to layer on the second leg of a vertical spread by also simultaneously selling to open the FNF December $ 26 puts for a premium between 50 cents- 60 cents per share.
That would reduce the total risk exposure in the trade to 20 cents-10 cents per share while keeping the upside maximized if the stock drops through the spread and closes below the lower strike. This isn’t a risk free trade of course, but it does improve the reward/risk profile if the stock consolidates a little at support. We used theoretical prices in this example because we can’t know how volatility and time-value erosion will affect the trade, but they are reasonable estimates.
The fundamentals on FNF are good, but the industry itself has been weakening. Volume has been spiking to the downside recently and if yields continue to rise, we expect FNF to diverge from the primary trend of the market and continue to fall to $22 per share. Outright short positions or a long put should be fine but this is one of those rare situations when a long vertical spread may offer some unique advantages. This is a shorter-term trade than we usually look for in our alerts but should be good for a little variety.
InvestorPlace advisors John Jagerson and S. Wade Hansen are co-founders of LearningMarkets.com, as well as the co-editors of SlingShot Trader, a trading service designed to help you make options profits by trading the news. Get in on the next trade and get 1 free month today by clicking here.
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