Getting Paid To Wait Through Dividends And Lucrative Covered Calls Mortgage REITs

by: Brian Gorban

I've always been hesitant to buy stocks in companies that pay no dividends as the only way to obtain real profit then is to sell the stock outright and be stuck with cash. Keeping that in mind, I thought of companies that are both ones I currently own or plan to own soon and how I can best maximize my profits:

Seven well-known and managed real estate investment trusts (REITs), which invest predominately in residential mortgage back securities (RMBS) look like a great way to make some profits. Essentially they make money off the spread between their borrowing costs and interest paid on the mortgage loans of the securities they buy. Therefore, knowing that the Federal Reserve will be keeping interest rates low for at least another two years, which bodes real well for these companies as that's their main cost of doing business. These names include American Capital Agency (NASDAQ:AGNC), Annaly Capital Management (NYSE:NLY), Capstead Mortgage (NYSE:CMO), Chimera Investment (NYSE:CIM), CYS Investments (NYSE:CYS), Hatteras Financial (NYSE:HTS), and Invesco Mortgage Capital (NYSE:IVR). These are all trading well below their historical valuations at right near book value, with Chimera and Invesco being the exceptions trading even lower at .85x price/book value. The market has its reasons to be worried with the continued depressed real estate market and people having problems paying their mortgages.

However, with the exception of Chimera, these other six REITs invest virtually all of their portfolios into agency securities which guarantee payment by the United States government, thereby virtually negating that risk. Moreover, the options market are paying what I see to be healthy premiums to take on this risk. I personally am long Annaly and Chimera, for example, and have sold Jan. 2012 17.50 calls and March 2012 3.0 calls, respectively. The returns for Annaly as of the $17.50 close yesterday is a $.90 call premium, meaning you have $16.60 invested and would receive two upcoming dividends totaling approximately $1.30 during the holding period. That means if the stock gets called away, in the 136 days until expiration, you'd gain $2.20 on your initial outlay of $16.60, meaning an annualized return of approximately 35% on this very low volatile stock as demonstrated by its .21 beta. If it doesn't get called away, just write more call options. Chimera, as well, looks enticing with the close at $2.95, March 2012 3.0 calls are bid at .$20.

That means if bought today, you'd have an initial outlay of $2.75 and receive two upcoming dividends totaling approximately $.26. In the 192 days until expiration, you'd gain $.31 on the initial $2.75 outlay, meaning an annualized return of about 21% with a stock that pretty much matches the volatility of the market demonstrated by its 1.16 Beta. If I had to just choose one, I personally recommend Annaly more in this case as it gives both the higher return and lower volatility for those wondering. Similar maneuvers can be made with the other REITs as I've been researching the option premiums for American Capital, Hatteras, and Capstead specifically and they look to show similarly favorable risk-reward ratios.

Disclosure: I am long NLY, CIM.