Trading the Homebuilders With Calendar Spreads

The homebuilding stocks have been among the best-performing issues over the past two years, but there is a growing acceptance of the notion that the housing boom can't last forever.

Last Thursday, Credit Suisse First Boston analyst Ivy Zelman downgraded the sector, saying that "future gains are built into current prices, making it hard to defend the bull case." The downgrade sent stocks such as Lennar (LEN Quote), Toll Brothers (TOL Quote), Ryland (RYL Quote) and Beazer Homes (BZH Quote) down 3% to 6% on the day.

The question isn't whether the industry will see slackening demand, but when and by how much. But for those of you who want to try your hand in this sector, I'll suggest one of my favorite options strategies -- the calendar spread. Sometimes known as a horizontal or time spread, it's employed when one anticipates a gradual price move in the intermediate term.

The benefits of this approach, vs. being outright long or short the stock, are limited risk coupled with potentially limitless profit, and the relative ease with which the position can be adjusted in response to price movement.

Reducing Cost

Bulls and bears alike can use the calendar spread, but I'm going to concentrate on a bearish example. A bearish calendar spread involves selling put options with a given strike and expiration date while simultaneously buying put options with the same strike price but a different expiration date. In the bearish case, the expiration date on the purchased (long) puts will be farther out than on the sold (short) puts. In other words, the life span of the puts you bought is greater than that of the ones you've shorted.

The rationale behind this is that while initially the two puts are offsetting, meaning you aren't likely to make or lose money in the short term, the position becomes more bearish (your delta increases) as time moves forward.