3 Bullish 14-Day Options Plays For A Volatile REIT Field

|
 |  Includes: AGNC, CIM, CYS, HTS, IVR, MFA, NLY, STWD, TWO
by: Rajiv Tarigopula

Annaly Capital Management (NYSE:NLY) has consistently ranked among the volume leaders of the New York Stock Exchange. Attracted by NLY's gigantic 13.2% yield, investors have flocked to this real estate investment trust that invests primarily in AAA-rated mortgage-backed securities in large numbers this year. Shareholders, though, have been treated to a very bumpy and volatile ride in recent weeks, thanks in large part to European economic uncertainty and continued investor dissatisfaction with the long-term prospects of the financial sector. For prospective longs and options traders, though, this volatility presents some fantastic basic trading opportunities.

Fundamentals

First, let's take a look at what makes NLY so appealing from a fundamental perspective. Revenue growth, growing profit margins, healthy cash flow, and increasing net income all point to a stable, growing company with solid future growth potential. However, while revenue has grown by almost 8% year over year looking at Q1 figures, EPS accretion was not seen - this should give potential investors some pause. Still, gross profit margin for NLY stands at 93%, with net profit margin at 93.6%. Moreover, price to book value is appealing - this may be a symptom of the greater uncertainty surrounding the financial industry.

With relatively stable return on assets in the 2% range over the next few years, and return on equity projected to stay above 12%, Annaly Capital Management is in a very sound market position. Compared with REIT peers, Annaly Capital Management is indisputably a giant. In terms of market capitalization, NLY is worth a little over $16 billion, while the majority of other heavily traded REITs all generally capitalize below $10 billion. However, from a P/E perspective, NLY's popularity among current investors places it in a somewhat awkward relative position for potential new investors: American Capital Agency Corp. (NASDAQ:AGNC), for instance, has a price/earnings ratio of ~5, while NLY's P/E stands at near 34. AGNC's net income is also over $1.2 billion; NLY had net income of a little over $500 million last year. Critics may point to these tidbits as reason not to invest in NLY. Still, this places this equity above peers such as Chimera Investment Corp (NYSE:CIM), MFA Financial (NYSE:MFA), Invesco Mortgage Capital Inc (NYSE:IVR), Hatteras Financial Corp (NYSE:HTS), Two Harbors Investment Corp. (NYSE:TWO), CYS Investments Inc. (NYSE:CYS), Starwood Property Trust Inc. (NYSE:STWD), and more.

All this leaves me somewhat bullish on NLY, like many others. The phenomenal, ostensibly sustainable dividend yield simply can't be argued with. So, here are three potential basic two-week (except for #3, to October '12) options plays for bullish investors (NLY closed Friday at just above $16) -

Options Play #1: Covered Call Buy-Write

  • Purchase, say, 100 shares of NLY, the underlying. At Friday's closing price, this should cost you $1633.
  • Write one call option, netting a premium that will depend on which strike price you choose. Using the June 16, 2012 17.0 Call as an example, this would net a premium of $3.
  • Thus, total cost for this options strategy would be $1630 - clearly difficult to justify unless the primary intent was to go long NLY and leave it at that; the $0.03 ask price for the $17 call comes to about 0.2% cushion/gain with this options play. Moreover, it would limit potential return to 4.1%.
  • However, since we're examining short-term options only, renewing this strategy every 14 days is a real possibility for the long NLY investor looking for a very small amount of cash benefit to owning some shares.
  • Judging by the volume and open interest on writing call options with higher strike prices, benefit would be minimal and commissions/trading costs would likely override. If NLY goes below $16 this week, however, the $16 strike price call option will be a very tempting play.

Options Play #2: Naked or Cash-Secured Put

  • The June 16, 2012 16.0 Put has an ask price of $0.12, with volume at 2,045 and open interest a little bit higher. Writing one contract here would again provide a minimal ($12) cash premium to the trader, who may be less confident about going long NLY above $16.
  • In my opinion, $16 is a fantastic entry point for NLY, especially before the upcoming dividend dates remaining in this calendar year.
  • Depending on how volatile this week gets (and its going to be a bumpy one, the way things are looking), keeping an eye on the in-the-money puts and prices for those contracts may be worth it, enabling longer-term NLY bulls to get in on shares of NLY at a lower cost basis. For instance, the June 16, 2012 18.0 Put (very likely to be assigned after purchase, since it's decently in-the-money) is going for $1.76 at the time of writing.

Options Play #3: Basic Longer-Term Call Option Purchase

  • For options traders with higher commissions/trading costs, or those simply desiring higher premiums with greater time value, longer-term options plays are a possibility on NLY. Bullish investors may look to the $17 or $18 strike price calls expiring on October 20. The first commands a price of $12 (100 share contract), while the second could go for less than $5 if the market exists.
  • Making a bet here before this week's anticipated central bank action may be a smart move; at the same time, the risk is much higher than in options plays #1 or #2.

Best of luck.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in NLY over the next 72 hours.