As mortgage interest rates are testing all-time lows, homebuilder optimism has surged to the highest level since 1998. The recent National Association of Home Builders/Wells Fargo Market Index beat analyst estimates and points to extreme optimism in the midst of a recession. As far as the options market is concerned, there was a large put option trade that is looking for the SPDR S&P Homebuilders ETF (NYSEARCA: XHB) to trade significantly lower by the start of 2021.
According to bankrate.com, the current 30-year mortgage rate is 3.06%. Pretty phenomenal considering how many mortgages are currently in forbearance. However, the housing market is hot and as a result, homebuilders are the most optimistic they’ve been in a very long time. The thing about sentiment is that extreme reading is generally contrarian in nature. With contrarian indicators they don’t provide immediate timing for a potential reversal but an indication of a reversal.
On Wednesday, the indication from the option market is that the reversal is nearing. The industry ETF isn’t just investing in homebuilders but also invests in companies like Home Depot Inc (NYSE: HD) and Lowe`s Companies Inc (NYSE: LOW), which both announced earnings yesterday. Late in the session, there was a trade for nearly 10,000 contracts on the 15 JAN 21 $43 put for around $1.50. That is a $1.75 million trade that is expecting XHB to trade below $43 by expiration.
Action to Take: The price isn’t necessarily in a great place to short but using options it can provide a high reward, low risk trade that will capitalize big if the price declines significantly. The 15 JAN 20 49/43 long call vertical can be bought for around $1.30. The max gain of $470 or 361% ROR is achieved if the price closes below $43 by expiration.
