KB Home (NYSE: KBH), whose colleagues include D.R. Horton, Inc. (NYSE: DHI) and Lennar Corporation (NYSE: LEN), reported earnings for the third quarter on Friday, and as one might have expected, they weren't the stuff of Wall Street dreams. This article gives a nice summary of the release. The loss per share worsened like crazy during the quarter compared to the year-ago data. The loss this year was $1.87 per share, and that was about four times the amount lost in the year-ago period. One thing to keep in mind, however, is that, on a non-GAAP basis in the previous year, the loss was $6.19 per share. The disparity here was caused by the addition of gains from discontinued operations in Q3 2007. No matter, expectations were for $1.22 per share for the current quarter, so KB Home nevertheless missed by a wide margin.

What fascinates me about KB Home is how the stock rebounded from its intraday low. I expected to see the shares in the dumps as I began to write this piece. Interestingly enough, as of this writing, shares are actually up over 1%! I wasn't the only one to notice this phenomenon. Dividend.com also mentioned how interesting the strong price action has been. In fact, at the time of this writing, AOL Finance says that KB Home's stock is up over 16% for the three-month period and up over 20% for the one-month period. What is this telling me? Does this mean I should buy the stock? I also should point out that the stock is not languishing at the 52-week low, either.

Well, it would have been pretty scary to buy KB Home at the 52-week low. But, I say it is kind of scary to buy KB Home now. If you think there is strength with this stock, then I say, at the very least, you've got to wait until it comes down before even thinking of buying. I just can't get myself to consider this homebuilder after seeing it miss estimates. Plus, we aren't out of the bad housing slump yet. The price action does give me pause, and I concede that you have to consider the effect of the discontinued operations on last year's earnings number. Still, it is my opinion that staying away from KB Home is best for now. The final decision, however, is yours.

Disclosure: I don't own any company mentioned; positions can change at any time.

TheStreet.com's Jim Cramer says the mortgage problem is in the process of cresting, which is why the stocks have largely bottomed.

We are in the heart of default country, and we knew we would be. This is the toughest moment. You need to go back and look at the calendar to realize the astonishing acceleration in defaults. It's simple: This moment two years ago is when the underwriting standards were the lowest, and this is the moment when the defaults will be the highest because the loans are resetting at high levels and most of the lenders, lenders like Countrywide (NYSE: CFC) (Cramer's Take), are more interested in getting as much out of a borrower as possible before kicking him out than working out the loan.

Think about it.

In the second quarter of 2006, the housing industry was going strong. We were in the 7-million-homes-changing-hands mode, and the vast majority of those homes required little money down, with home equity loans being taken out immediately to pay whatever little interest was being charged. These were the moments of the ultimate no-doc-high-fee loans by New Century Financial, Ameriquest, Resmed (Ditech), American Home Mortgage, Novastar, and of course, Countrywide. This was when the homebuilders' mortgage arms lent the most terribly.

MOST NOTEWORTHY: Yahoo!, Cigna and Aegean Marine were today's noteworthy upgrades:

• Citigroup upgraded shares of Yahoo! (NASDAQ: YHOO) to Buy from Hold as they believe Microsoft (NASDAQ: MSFT) is unlikely to walk away from Yahoo! and that there is potential Microsoft could bid $34/share.
  
• Credit Suisse upgraded Cigna (NYSE: CI) to Outperform from Neutral citing the company's favorable business mix.
  
• Stephens upgraded shares of Aegean Marine (NYSE: ANW) to Overweight from Equal Weight on valuation as they see an attractive entry point at current levels.

OTHER UPGRADES:

• JMP Securities raised D.R. Horton (NYSE: DHI) to Strong Buy from Outperform and Pulte Homes (NYSE: PHM) to Outperform from Market Perform.
  
• Goldman added Hertz Global (NYSE: HTZ) and Electronic Arts (NASDAQ: ERTS) to its Conviction Buy List.

MOST NOTEWORTHY: Suntech Power, Premier Exhibitions and the Homebuilders Sector were today's noteworthy initiations:

• Citigroup named Suntech Power Holding (NYSE: STP) their top pick for China solar due to its leading scale and technology roadmap for higher cell efficiency, initiating shares with a Buy rating and $55 target.
  
• Merriman believes Premier Exhibitions (NASDAQ: PRXI) can move to the $14.50-$17.00 through the continued monetization of the company's current tours, the launching of additional tours and the value of the Titanic artifacts on hand. The firm started shares with a Buy rating.
  
• Lehman initiated D.R. Horton (NYSE: DHI), Ryland Group (NYSE: RYL), Toll Brothers (NYSE: TOL) with Overweight ratings and an $18 target, $31 target and $27 target; KB Home (NYSE: KBH) with an Equal Weight rating and $24 target; and Hovnanian Enterprises (NYSE: HOV) with an Underweight rating and $8 target.

OTHER INITIATIONS:

• Citigroup initiated Yingli Green Energy (NYSE: YGE) with a Hold rating and $24 target.
  
• UBS initiated Citrix Systems (NASDAQ: CTXS) with a Neutral rating and $38 target.
  
• JP Morgan initiated Biodel (NASDAQ: BIOD) with an Overweight rating.

DR Horton Inc. (NYSE: DHI) shares are rising this morning on news that the Bush administration is working behind the scenes with the home-lending industry on a plan to extend lower, introductory interest rates on home loans. Treasury Secretary Henry Paulson with loan servicing companies and other industry executives yesterday to come up with a loan modification plan in the wake of the subprime crisis. No formal agreement was announced, but an agreement could be be revealed in the next week or two. Also helping the situation are comments from Fed Chairman Ben Bernanke, who hinted at further rate cuts in December. If you think that the company won't fall by too much in the coming months, then now could be a good time to look at a bullish hedged trade on DHI.

After hitting a one-year high of $31.13 in February, the stock hit a one-year low of $10.15 on Tuesday. DHI opened this morning at $10.78. So far today the stock has hit a low of $10.77 and a high of $11.99. As of 10:55, DHI is trading at $11.97, up $1.50 (14.3%). The chart for DHI looks neutral and steady, while S&P gives the stock a positive 4 STARS (out of 5) buy rating.

Things keep getting worse and builders get more and more cautious. In fact, according to the Commerce Department's most recent survey, housing starts dropped 10% to an annual pace of 1.19 million in September from a 1.33 million rate in August. That's worse than economists expected. Briefing.com's survey showed economists estimated a more modest fall to 1.29 million.

We haven't seen a housing market this weak since 1993 and the future doesn't look any better. Housing permits were down 7% to an annual rate of 1.23 million in September from 1.32 in August. That's the lowest level for permits in 12 years.

This news follows the report that the Mortgage Bankers Association will release today at its annual convention indicating falling mortgage originations and a builder's confidence survey that was released Tuesday indicating that builder's confidence is at record low levels. The nation's builders are hit hard. The most recent to report was the nation's largest, D. R. Horton (NYSE: DHI), whose orders dropped by 39%. Last week, Moody's downgraded Lennar (NYSE: LEN), Centex (NYSE: CTX) and Pulte (NYSE: PHM) homes to junk bond status.

DR Horton Inc. (NYSE: DHI) stock hit a new 52-week low today after UBS initiated coverage on the homebuilder with a Sell rating and competitor Lennar Homes (NYSE: LEN) posted a larger-than-expected loss. August's existing home sales data was also well short of good news for the housing industry. If you think this stock won't be rising too far in the coming months, then it could be a good time to look at a bearish hedged play on DHI.

After hitting a one-year high of $31.13 in February, the stock has tumbled, making new lows almost daily. This morning, DHI opened at $13.29. So far today the stock has hit a low of $12.84 and a high of $13.40. As of 11:25, DHI is trading at $13.08, down $0.48 (-3.5%). The chart for DHI looks bearish and steady, while S&P gives the stock a positive 4 STARS (out of 5) buy rating.

For a bearish hedged play on this stock, I would consider a January bear-call credit spread above the $17.50 range. A bear-call credit spread is an options position that combines the purchase and sale of call options to hedge risk in case the stock doesn't do what you think but still leverage nice returns. This particular trade will make an 11.1% return in 4 months as long as DHI is below $17.50 at January expiration. DR Horton would have to rise by more than 33% before we would start to lose money.

DHI hasn't been above $17.50 since August and has shown resistance around $15.10 recently. This trade could be risky if the housing market turns around quickly as a result of the Fed's actions, but even if that happens, this position could be protected by a few more months of negative housing news.

Brent Archer is an options analyst and writer at Investors Observer.
DISCLOSURE: At publication time, Brent neither owns nor controls positions in DHI.

CNBC's Jim Cramer is bearish on most of the housing sector, even predicting the demise of a few major players including DR Horton (NYSE: DHI) and Beazer Homes (NYSE: BZH),. But he believes Toll Brothers Inc. (NYSE: TOL) will be one of the least damaged companies in the industry. Cramer notes that Toll Brothers is okay because the company only really builds luxury homes – Toll's customers are not high risk loan candidates, and they are not terribly damaged by the mortgage issues surrounding the market right now. If you are inclined to agree, then it could be a good time to get into a bullish hedged trade on Toll.

After hitting a one year high of $35.64 in February, the stock has been beaten down with the rest of the housing sector this year, hitting a one year low of $18.85 earlier this month. This morning, TOL opened at $21.89. So far today the stock has hit a low of $21.26 and a high of $21.96. As of 10:45, TOL is trading at $21.29,down $0.71 (-3.2%). The chart for TOL looks bearish but improving slightly, while S&P gives the stock a neutral 3 STARS (out of 5) hold rating.

If you agree with Cramer, then for a bullish hedged play on this stock, I would consider an October bull-put credit spread below the $17.50 range. A bull-put credit spread is an options position that combines the purchase and sale of put options to hedge risk in case the stock doesn't do what you think but still leverage nice returns. For this particular trade, we will make an 11.1% return in just 2 months as long as TOL is above $17.50 at October expiration. Toll would have to fall by more than 17% before we would start to lose money.

TOL hasn't been below $17.50 at all in the past year and has shown support around $21 recently. This trade could be risky if investors don't consider the positive aspects of TOL before panic-selling the stock, but this position could gain protection if the Fed decides to take action to help the credit problem.

Brent Archer is an options analyst and writer at Investors Observer.

DR Horton Inc. (NYSE: DHI) opened at $17.03. So far today the stock has hit a low of $16.91 and a high of $17.56. As of 11:00, DHI is trading at $17.24, up $0.08 (0.5%).

DHI has been trading in a sideways pattern for the past three months. The stock is falling today after Jim Cramer put out a fairly negative quote on the company's future. Cramer stated that based on what he saw in the company's balance sheet that he was seriously questioning whether or not the company would be able to "make it". Technical indicators for DHI are bearish and steady, while S&P gives the stock a negative 2 STARS (out of 5) sell rating.

For a bearish hedged play on this stock, I would consider a September bear-call credit spread above the $20 range. A bear-call credit spread is an options position that combines the purchase and sale of call options to hedge risk and leverage returns. For this particular trade, we will make an 8.7% return in just 2 months as long as DHI is below $20 at September expiration. DHI would have to rise by 15% before we would start to lose money.

DHI has been above $20 by a few cents in the past month but has fallen hard to $17 and has shown resistance near $19.80 recently. This trade could be risky if the housing market sees a resurgence, but even if that happens, it would be tough for the stock to get over the $20 level with the amount of skepticism there is about housing right now.

Brent Archer is an options analyst and writer at Investors Observer.

To be sure, it was not an incrementally positive data point for the housing sector. New housing starts declined by 2.1% in May, to a seasonally-adjusted 1.47 million units -- the first decline in four months -- as builders pulled-back in the face of a rising inventory of residential homes, the U.S. Commerce Department announced Monday.

Starts of single-family homes declined 3.4%. However, overall building permits rose 3%, aided by a rise in multi-family permits.

The housing slump has been a two-edged sword for the U.S. Federal Reserve, business decision makers, and others who follow the economy. On the one hand, the slump has slowed economic growth and taken some pressure off core commodity / raw material prices - a condition that has moderated inflation. On the other hand, that same slump threatens to reduce economic activity by too great an amount -- with some Fed watchers arguing that the slump could cause a recession.

Specifically, Fed data indicated that the recession in the housing sector cut 0.9 percentage points from U.S. economic growth in Q1 1007, after cutting 1.2 percentage points in 2H 2006.

Fly Analysis: While inflation remains above the Fed's target range, Tuesday's housing data provides another data point for those who argue that U.S. economy should be moved to the front burner: U.S Q1 GDP growth came in at a scant 0.6%, according to preliminary U.S Bureau of Economic Analysis data. Further, while Tuesday's housing data does not guarantee further GDP slowing in Q2, the data does send a strong signal that those hoping for an economic boost from the housing sector are not likely to see that boost in Q2, and perhaps, for considerably longer.

The "Totally Informal Economics Roundtable" (TIER) met this week. This esteemed Roundtable achieves a quorum whenever yours truly and his three astute economist friends from graduate school convene to discuss matters economic ... or to celebrate a birthday. This week, the topic was residential housing's long-term prospects.

The TIER summarized the housing sector's current circumstance: the sector appears to be correcting, following a building, buying and (perhaps most importantly) financing boom that led to above-average appreciation rates and an alarming increase in non-traditional mortgage approvals.

The TIER agreed that the residential real estate sector faces a choppy / sluggish next two years, as the number of sub-prime loan defaults -- and the segment's impact -- become more-clear. Real estate officials, Wall Street analysts, economists and other parties also eagerly await data in the months ahead on unsold new / existing homes (inventories), mortgage applications, and borrower repayment performance: these stats will provide a fuller picture of the extent of the housing sector's slowdown and its impact on house values.

Were you watching CNBC after the market close today? If so, you may be cancelling your plans to sink all your home's equity into a big remodel. In an unusually frank and sober prediction, D.R. Horton, Inc. (NYSE:DHI) CEO Donald Tomnitz told the audience of millions of market watchers that "2007 is going to suck, all 12 months."

David Gaffen from the Wall Street Journal's MarketBeat blog was watching, and he wonders if it's not just a reaction to D.R. Horton's not-exactly-stellar stock performance. Though only down a penny today to $24.55, the stock is off 20% since its February 2, 2007 high near $31 -- a rough month, indeed.

The good news (sort of)? Tomnitz thinks 2008 will be better. Not good. Better than the suck-icious 2007, at least. Is this a case of let's-give- the-worst-case-projection-and-hope-no-one-blames-me-when-it- happens? Or is it really true? Either way, the homebuilder's stock isn't doing any better since his words; it's down over a percent in after-hours trading.

I, for one, won't bail out of the market but I think I'll wait to refinance... with this kind of talk, the only thing I see on the horizon is cheaper interest rates. And I'm certainly not going to hire Donald to run pep rallies anytime soon.

Bill Miller, the famed Legg Mason fund manager, was on television last week. He said he is long on housing stocks.

In Barron's Up and Down Wall Street column (subscription required), Doug Kass of Seabreeze Partners said he was short housing stocks - no big surprise there. Kass referred to order cancellation as the reasoning for his bearishness.

Typically, publicly traded homebuilders have cancellation rates of 15% of orders. However, that number has jumped considerably. Cancellation rates of publicly traded homebuilders:

• Centex (NYSE: CTX) - 37%
• DR Horton (NYSE: DHI) - 40%
• KB Homes (NYSE: KBH) - 53%
• Lennar (NYSE: LEN) - 31%
• Pulte Homes (NYSE: PHM) - 36%
• Beazer (NYSE: BZH) - 57%
• Hovnanian (NYSE: HOV) - 35%
• MDC Holdings (NYSE: MDC) - 49%
• Standard Pacific (NYSE: SPF) - 50%

These numbers (from the Barron's article) are so bad that the worst might be unfolding right now.

TheFly's advice, Miller tends to be too early and Kass is often too negative when the worst is already priced in the stocks. I'd say, start following these stocks again, expecting a bottom in the spring and early summer.

The most recent rally is mostly from an oversold condition. I'd wait for another correction and see where the industry fundamentals stand.