Homebuilder D.R. Horton, Inc. (NYSE:DHI) is set to report its fiscal Q2 results before Wednesday’s open. And if recent history is any indicator, as well as the firm option pricing heading into the event, DHI stock should be fairly volatile and a market headliner within that morning’s announcements.
In front of tomorrow’s pre-market release, Wall Street is forecasting profits of 39 cents per share. The earnings view is a penny less than 2014’s same quarter result, which marked a profit beat in excess of 11%.
When it comes to earnings, fairly large profit beats and misses are par for D.R. Horton. So are stiff post-report reactions by investors in DHI stock. Over the last six quarters, the company has announced earnings surprises of 11.4%, -8.2%, -34.7%, 11.8%, 20% and -2.4%.
At the same time and in the immediate aftermath, shares of D.R. Horton have gone on to produce immediate closing moves of 5.5%, 2.2%, -11.5%, 8.3%, 9.8% and 4.7%. D.R. Horton stock’s post-earnings movement results in an average return of 3.2% if we account for the lone negative result.
If one simply looks at the percent magnitude of each move, the average close-to-close change in DHI shares is 7% with one standard deviation of wiggle room of 3.5%.
DHI Weekly Trading Chart
In front of Wednesday’s earnings report and as D.R. Horton’s weekly trading chart reflects, shares of DHI have been consolidating for the last three weeks and change. The fairly tight and lateral range in DHI stock has found support from prior resistance and 2013’s high-water mark.
Overall, the DHI price action is bullish and has found the homebuilder outperforming the broader market thus far in 2015. However, the relative performance is well behind comparable gains of the past 16 months carved out in the likes of the SPDR S&P 500 ETF Trust (NYSEARCA:SPY), as well as the SPDR S&P Homebuilders (ETF) (NYSEARCA:XHB).
D.R. Horton Most Active Option
In Monday’s session and maybe a reflection of the discussed technical positioning and investor optimism for some upside catch-up; abnormally heavy volume of about 8,700 in the DHI May $30 calls appears to be looking for a move higher in D.R. Horton shares.
With open interest of 29,000, some of the trading in D.R. Horton may have been on a closing basis. However, as the only noticeable activity and implieds bid solidly on the session, buyers were certainly driving the action. At last check, the May $30 call was at 63 cents and requires a move higher of 9.3% to break even at expiration in 25 calendar days.
D.R. Horton Volatility
More important and also reflected by D.R. Horton’s trading chart, implied volatility (blue line) and the prices being paid by option traders in front of the earnings report are matching their highest levels in over a year and bid well-above DHI’s (brown line) underlying stock volatility.
Net option traders in D.R. Horton are collectively preparing for both a volatile event and one which will also result in a premium crush in option prices once the dust clears. It should be noted D.R. Horton is the first in a series of earnings announcements from the homebuilders. Coming up, PulteGroup, Inc. (NYSE:PHM) is set to report this Thursday before the market open, while Ryland Group Inc (NYSE:RYL) and Beazer Homes USA, Inc. (NYSE:BZH) will release quarterly results April 30.
D.R. Horton Stock Event Pricing
Bearing D.R. Horton’s volatility readings, the crush or reduction in option premiums may have a couple stages as the potential for a subsequent sympathy move in DHI stock is not out of the question.
Based on the at-the-money May contract currently priced around 46% implied volatility, I’d expect initially at least 10 points or so are peeled off during Wednesday’s session after the announcement. That would find D.R. Horton option prices still trading slightly above underlying volatility and set for some continued, heightened stock movement in DHI shares as the other homebuilders report earnings.
Examining what traders are pricing for DHI stock in dollar terms, the weekly April 24 “earnings pure play” contract is pricing in a 68% chance shares of D.R. Horton will be contained to a +/- move of $2.65. That produces a stock range of $25.35-$30.65 based on Monday’s close near $28 in DHI.
Related and similarly, the weekly April 24 $28 straddle priced for about $2 on 91% implied volatility requires shares of DHI to move beyond $26 or $30 in order for a buyer to break even. The pricing requires a move in D.R. Horton stock of just over 7% to see a positive return.
The $2 of premium for the D.R. Horton straddle is on par with the average “magnitude” move we calculated earlier. However, don’t think this means buying the straddle is as an opportunistic strategy that you should, on average, manage to break even with given historical stock returns in DHI following earnings.
Rather, think about the forementioned 68% likelihood of D.R. Horton stock being contained, maybe the real and less severe mathematical mean of 3.2% and what can go wrong when history, especially one from a small sample size, doesn’t repeat or nearly resemble what’s required to profit from otherwise, expensive premium.
As of this writing, investment accounts under Christopher Tyler’s management do not currently own positions in any of the securities or their derivatives mentioned in this article. The information offered is based upon his observations and strictly intended for educational purposes only; the use of which is the responsibility of the individual.
