Home is where the range is

Sandwiched between next week’s existing home sales and new home sales reports, homebuilder KB Home (KBH) is scheduled to release earnings next Wednesday, March 22.

Yesterday’s trading in KBH was a tale of two markets. Around midday the stock was up roughly 1.3%—a healthy gain, but not as big as S&P 500’s (SPX). Shares were still toward the middle of the trading range they’d been stuck in for nearly a month after a 15% pullback from their early February high above $40:

The bottom of the chart highlights the divergence between two types of volatility. While historical volatility (HV) was near its lowest levels of the past several months, implied volatility (IV) was near a two-month high. Translation: The options market was expecting KBH to be more volatile over the next 30 days than it had been over the past 30 days—perhaps reflecting the reality that the stock has been stuck in a trading range but has a potentially price-moving inducing event (earnings) on the horizon.

KBH’s options market, on the other hand, was much busier Wednesday—10,000 contracts traded in the April $38 calls (top) and 10,100 changed hands in the April $32 puts (bottom):

At first glance those trades may appear to be a wash in terms of directional sentiment—a large out-of-the-money (OTM) call trade and a large OTM put trade, with strike prices roughly $3 above and below the stock price. The strike prices also happened to be a little above and below the boundaries of the stock’s trading range over the past few weeks.

But it could mean a trader was putting on a strangle position—either buying the two options in anticipation of a price move (up or down) big enough to offset the cost of the options, or selling them  with the expectation the stock would continue to be relatively stagnant. (Intraday data showed 10,000-contract trades did, in fact, occur around the same time in both options.)

But there was one additional detail to consider. While yesterday’s volume in the $38 calls dwarfed its  open interest (OI), the OI in the $32 puts was 7,000—which means the majority of the 10,100 contracts that traded could have been traders getting out of positions. If that was the case (today’s OI totals should show whether positions increased or decreased from yesterday), it could mean yesterday’s options activity consisted mostly of traders getting into calls a few days before earnings.

A final note: Yesterday around 1:30 p.m. ET, the options market was estimating a +/-5% earnings-day price move for KBH. Meanwhile, the April $32–$38 strangle was trading around $1.95. The breakeven prices for a strangle are the call strike price plus the strangle cost, and the put strike price minus the strangle cost. That means (at expiration) a long strangle trader would need the stock to be above $39.95 or below $30.05 to turn a profit (around 5.5% above and below where the stock was trading yesterday), while a strangle seller could profit if the stock was between those two levels.

Today’s numbers include (all times ET): “Quadruple Witching” expiration (stock options, index options, stock index futures, single stock futures), Industrial Production (9:15 a.m.), Consumer Sentiment (10 a.m.), Leading Indicators (10 a.m.).

Today’s earnings include: Ballard Power Systems (BLDP).

Click here to log on to your account or learn more about E*TRADE's trading platforms, or follow the Company on Twitter, @ETRADE, for useful trading and investing insights.