While President Donald Trump loves to talk a tough game, even he must have realized the imprudence of pulling too many levers at once. Earlier this week, the White House implemented long-threatened tariffs on key economic partners Canada, Mexico and China. However, the move prompted serious backlash, causing the administration to delay some of the levies. In turn, homebuilder DR Horton (DHI) looks much more intriguing.
At first glance, DHI stock might not seem directly related to the high-level drama in Washington. But as Quiver Quantitative pointed out recently, both mortgage rates and tariffs have weighed heavily on U.S. construction in January. In particular, multi-family housing units experienced the most significant spending decline — and that naturally represents a serious headwind for the homebuilding industry. It’s no surprise, then, that as Trump tariff talks accelerated, DHI began looking shaky.
Fortunately for bullish investors, though, it appears that cooler and more prudent heads are prevailing. Without getting political, it’s a move that caught me personally off-guard. President Trump loves to evoke an image of a tough sheriff cleaning up the Washington swamp. One way to do this is to get tough on America’s partners, which Trump has often stated are ripping off the nation.
However, the tariff-affected countries have threatened retaliation, articulating a critical point: no one’s going to emerge from a trade war unscathed. Therefore, Trump backing off the accelerator is a positive sign, at least for now. Sure enough, DHI stock represented one of the highlights in Barchart Screeners, specifically the J-Pattern.
To make a long story short, the J-Pattern or J-Hook represents a technical blowoff move following a bull-bear cycle. In this way, the signal is similar to a bullish pennant or flag formation. After an initial rally, the target security enters a consolidation phase. Once this phase finishes, the stock shoots higher.
Two Ways to Tackle DHI Stock
Assuming confidence in the J-Hook, the simplest approach to DHI stock is to acquire shares in the open market. Based on technical analysis, it’s quite possible that DHI will start targeting the $142 resistance level. Should this point be breached, the next target would be the security’s 200-day moving average, which currently stands near $160.
By the way, $160 is a rather conservative target. Right now, Wall Street analysts — which rate shares as a consensus Moderate Buy — carry a mean price target of just under $172. Of course, the question is when such a lofty price will materialize. Still, a 28% move is nothing to scoff at, especially when the underlying company pays a dividend (albeit a small one).
The other approach is to consider DHI stock options. Before engaging the derivatives market, investors should read up on the risks and the importance of money management. It’s also worth brushing up on the basics of determining the perceived value or premium of options.
With that in mind, I approach options in a completely unorthodox manner. Quite frankly, I’m not obsessed with the "quant” stuff — the implied volatility, delta-neutrality, theta-optimization, gamma-scalping and vega-hedging. People can nerd out on these metrics if they want.
My point is very simple: if the stock moves in an unexpected direction, all that hedging won’t mean squat [actually, there’s another word but let’s just stick with squat].
Instead, I look at probabilities, both baseline and dynamic. For the former, pricing data from January 2019 reveals that a position entered at the beginning of the week has a 56.83% chance of rising by the end of it. Over an eight-week period, this probability rises to 62.22%.
Now, over the past five sessions, DHI stock gained over 6%. Whenever DHI returns between 5% and 10% in a one-week period, FOMO or the fear of missing out kicks in. In the subsequent week, DHI’s long odds reach 61.76%. Interestingly, during the fourth subsequent week, the long odds peak at 64.71%.
With this market intelligence, I’m intrigued by the 133/144 bull call spread expiring April 4. This transaction calls for buying the $133 call and simultaneously selling the $144 call, using the proceeds from the short call to partially offset the debit paid of the long call. The trade risks $480 for the chance to earn $620 or a 129.17% payout.
Risky? Yes but Maybe Not as Much as Advertised.
To be sure, the above bull spread is risky, with Barchart noting that the probability of profit is only 40%. Granted, if the probability was higher, the payout would be significantly reduced. Wall Street isn’t in the habit of handing out free money.
However, based on actual market dynamics, it’s my speculation that DHI stock has a surprisingly good chance of at least breaking even on this trade, where the threshold stands at $137.80. In a Monte Carlo simulation (guided by the aforementioned market dynamics), DHI fell just a few cents shy of the mark.
From my estimation, the probability of profit should be at least 50/50, not 40%.
What I’m banking on is the fundamental catalyst that DHI’s empirical data doesn’t fully capture. Up until just recently, the U.S. was on a road toward an unmitigated trade war. Now, some pragmatism is returning to the White House. That’s a big relief that could tilt the odds in the bulls’ favor.
