A Recovery In Housing Could Lead to a 120% Gain
Trade summary: A bull call spread in Zillow Group, Inc. (Nadaq: Z) using the August $65 call option which can be bought for about $4.15 and the August $70 call could be sold for about $2.59. This trade would cost $1.56 to open, or $156 since each contract covers 100 shares of stock.
In this trade, the maximum loss would be equal to the amount spent to open the trade, or $156. The maximum gain is $344 per contract. That is a potential gain of about 120% based on the amount risked in the trade.
Now, let’s look at the details.
As the economy rebounds, it seems as if real estate is bouncing back. According to PR Newswire,
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“Homes continue to fly off the market just weeks after they’re listed — faster than any time in at least the past two years, according to Zillow’s Weekly Market Report. That’s despite newly pending sales falling week over week for the first time since late May, though they remain well ahead of last month’s pace.”
Homes sold in the week ending June 27 were typically on the market just 20 days before a contract to sell is signed, the fewest number of days recorded since at least 2018 (when Zillow began tracking the data).
That time on market is one day less than last week, and full week less than the same period a year ago.
Homes sold last week typically went under agreement in a week or less in six of the nation’s 50 largest metros: St. Louis (7 days), Indianapolis (6), Seattle (6), Kansas City (5), Cincinnati (5) and Columbus (4).
List prices continue to climb as more-expensive listings stage a comeback,
The median price of homes listed for sale nationwide was $337,160 last week, up 0.6% from a week ago and 3.8% from the same time last year.
In a reversal of the prevailing trend from earlier in the spring, newly listed homes in the most-affordable price ranges are now down far more compared to a year ago than listings in more-expensive tiers – contributing the overall bump in median list price.
List prices last week were higher than a year ago in 45 of the 50 largest U.S. markets. They were up the most year over year in Cincinnati (+16.6%), and down the most in Chicago (-1%).
In a sign of a tightening market, inventory continues to fall.
New for-sale listings nationwide fell 5.1% week over week, though they remain up 5.2% from a month ago.
Total inventory was down 0.7% from the previous week, and is now 20.7% lower than at the same time last year.
This is potentially bullish for Zillow which is near the upper end of a trading range.
The weekly chart shows this is a long-term resistance level and a break out could drive prices significantly higher.
A Specific Trade for Z
For Z, the August options allow a trader to gain exposure to the stock. This trade will be open for about six weeks and allows for traders to turn over capital quickly, potentially compounding gains several times a year.
An August $65 call option can be bought for about $4.15 and the August $70 call could be sold for about $2.59. This trade would cost $1.56 to open, or $156 since each contract covers 100 shares of stock.
The amount paid to enter the trade is the largest possible loss on the trade. This is generally true whenever a trader is creating a debit to enter an options trade. “Creating a debit” means there is a cost to enter the trade. You could create a debit by simply buying puts or calls to open a directional trade.
In this trade, the maximum loss would be equal to the amount spent to open the trade, or $156.
The maximum gain on the trade is equal to the difference in exercise prices less the amount of the premium paid to open the trade.
For this trade in Z, the maximum gain is $344 ($70- $65= $5; 5- $1.56 = $3.44). This represents $344 per contract since each contract covers 100 shares.
Most brokers will require minimum trading capital equal to the risk on the trade, or $156 to open this trade.
That is a potential gain of about 120% based on the amount risked in the trade. The trade could be closed early if the maximum gain is realized before the options expire.
A Trade for Short Term Bulls
As with the ownership of any stock, buying Z could require a significant amount of capital and exposes the investor to standard risks of owning a stock.
To reduce the risks of a trade, an investor could purchase a call option. This allows them to benefit from upside moves in the stock while limiting risk to the amount paid for the options. However, buying a call option can also require a significant amount of capital and includes the risk of a 100% loss.
Whenever an option is bought, the maximum risk is always equal to 100% of the amount of spent to purchase the option. Since options cost significantly less than a stock, the risk in dollar terms will usually be relatively small to own an option.
To further limit the risks of the trade, an investor could use a bull call spread. This strategy consists of buying one call option and selling another at a higher strike price to help pay for the cost of buying the first call. The spread strategy always reduces the risk of an options trade.
This strategy is designed to profit from a gain in the underlying stock’s price but the benefit of avoiding the large up-front capital outlay and downside risk of outright stock ownership. The potential risks and rewards of this strategy are summarized in the chart below.
Source: The Options Industry Council
Both the potential profit and loss for the bull call spread are limited. The maximum loss is equal to the net premium paid when the trade is opened. The maximum profit is limited to the difference between the strike prices, less the debit paid to put on the position.
This strategy could be especially appealing with high priced stocks where the share price and options premiums are often a significant commitment of capital for smaller investors.