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Tuesday, June 6, 2017

Established New Position in D R Horton Inc.

Earlier today, a covered calls position in home builder PulteGroup Inc.(ticker PHM) was liquidated when the Jun2017 Call options were assigned early and the stock sold (see detailed result of PHM position here: link). The majority of this cash was used to establish five June 2017 100% cash-secured Put options position in another home builder (D R Horton Inc.) at the $33.00 strike price.  The short Puts were chosen instead of the comparable covered calls since the potential return-on-investment result was slightly higher for the Puts in this instance.  As detailed below, there is potential for a +1.1% absolute return in 11 days (equivalent to a +37.6% annualized return-on-investment) with this investment.

D R Horton screens attractively on the Covered Calls Advisor's preferred quality, value, and growth metrics and currently receives the highest rating (5 stars) from S&P Capital along with a $38 12-month price target.  A discounted cash flow estimate (shown in the chart below) using a 6% discount rate and 9% growth rate results in an even more attractive $46.70 fair value estimate.
Note: the $35 'Buy Price' shown provides a 25% margin-of-safety below the DCF Fair Value price.

D R Horton Inc. (DHI) -- New 100% Cash-Secured Puts Position
This position was established when the price of D.R. Horton was $33.10 (0.3% downside protection to the strike price) and 11 days remaining until the options expiration date.

The implied volatility of the Put options was 18.2 when this position was established and the price received was $.39 per share.    

The transaction was as follows:
06/06/2017  Sold 5 DHI Jun2017 $33.00 100% cash-secured Put options @ $.39
Note: the price of DHI was $33.10 today when this transaction was executed.

The Covered Calls Advisor does not use margin, so the detailed information on this position and a potential result shown below reflect the fact that this position was established using 100% cash securitization for the five Put options sold.

A possible overall performance result (including commissions) would be as follows:
100% Cash-Secured Cost Basis: $16,500.00
= $33.00*500
Note: the price of DHI was $33.10 when these options were sold

Net Profit:
(a) Options Income: +$186.80
= ($.39*500 shares) - $8.20 commissions
(b) Dividend Income: +$0.00
(c) Capital Appreciation (If D R Horton is above $33.00 strike price at Jun2017 expiration): +$0.00
= ($33.00-$33.00)*500 shares

Total Net Profit (If D R Horton stock price is above $33.00 strike price at Jun2017 options expiration): +$186.80
= (+$186.80 options income +$0.00 dividend income +$0.00 capital appreciation)

Absolute Return:: +1.1%
= +$186.80/$16,500.00
Annualized Return: +37.6%
= (+$186.80/$16,500.00)*(365/11 days)

The downside 'breakeven price' at expiration is at $32.61 ($33.00 - $.39), which is 1.5% below the current market price of $33.10.

Using the Black-Scholes Options Pricing Model in the Schwab Hypothetical Options Pricing Calculator, the probability of making a profit (if held until the Jun 16th, 2017 options expiration) for this DHI short Puts position is 54.3%%. This compares with a probability of profit of 50.3% for a buy-and-hold of DHI shares over the same time period. Using this probability of profit of 54.3%, the expected value annualized return-on-investment (if held until expiration) is +20.4% (+37.6% * 54.3%), a satisfactory risk/reward profile for this short-term investment.  

The 'crossover price' at expiration is $33.49 ($33.10 + $.39).  This is the price above which it would have been more profitable to simply buy-and-hold D R Horton stock until the June 16th, 2017 options expiration date rather than selling these Put options.