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November 18, 2005

Home Buying

Today's action exemplified the grindingly boring nature of most options expiration days. Equity indices more or less stayed near even as traders shuffled around their hedges. One story, though, presents the perfect opportunity to present a couple of lessons on short selling. The Beazer Homes board announced around mid-afternoon that they plan to boost their stock-buyback program. Nearly a quarter of the shares outstanding will be retired over the next 36 months.

A devious thing to do on an options expiration day, the announcement shot the company's shares up nearly 6%. In combination with the October rally, shares have been pushed up about 30% in the last month and have set a new, all-time high. Which brings us to lesson #1: when shorting, always use stop-losses. Short squeezes can be violent and last far longer than believable. Anyone who tried shorting tech as the market was falling sharply in late 1999 can vouch for this fact.

So, how are the other homeys doing? Several, such as Centex and Brookfield have faired well, but most are still languishing. A quick glance at the charts of Toll Brothers and Dominion Homes shows that these two industry participants are still near their recent lows. Which brings us to lesson #2: when shorting a theme, such as the housing bubble, concentrate your shorts on the weaker players. A chart of Beazer from the July high to the October inflection shows that BZH did not fall as sharply as the other homeys. This fact could have served as a clue to its strength. A comparison of financials and insider selling stats will show even more implied relative strength.

Next week brings us Thanksgiving, so trading is likely to be light all week, especially next Friday. If money managers are still at work trying to make their year, the holiday week could give them an opportunity to ramp things higher. In addition, the dollar has not yet turned lower, so I do not see an immediate end to this rally. Nevertheless, I am starting to look for selective shorts.

Disclosure: None


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