Condemned? Options Traders Taking Defensive Stance on Commercial REITs

Option traders are positioning in accordance with ominous words out of Goldman Sachs (GS) today on the state of the commercial real estate and REIT markets. In a report out today, Goldman noted that while commercial REITs have outlasted the broader market in the present cycle, their fundamentals are only now starting to deteriorate, with some segments of the sector likely to buckle further on low demand for retail and leisure activities, tight credit, and the likelihood of higher interest rates adding to funding pressures. Earlier this week, a report from New York-based research firm Real Capital Analytics predicted a rise in US commercial property defaults for similar reasons.

Having already noted an unusual level of bearish option trading activity in the country’s second-largest owner of regional shopping malls, General Growth Properties (GGP), earlier in the week, today two more commercial REITs put in appearances on our scan of relative volume gainers. Shares in Simon Property Group (SPG) declined 2% in early trading to $94.60, and a near-eightfold increase in option trading volume appeared centered in July calls. We can confirm that 100-strike calls traded to the middle of the market at $2.02, while calls at the next-highest strike commanded 92 cents.

A trader looking to bet on continued doldrums for the mall REITs would likely play this as a short call spread, pocketing the $1 credit in the expectation that Simon Property Group shares will remain well below the $100 line through July.

Directionally neutral volatility plays were the preferred vehicle for option traders in another commercial REIT today. Shares in ProLogis (PLD), the world’s largest owner, manager and developer of industrial space, declined 1.3% to $57.41, while an increase in its option trading volume to more than 9 times the normal level appeared in a 1,030-lot position at the October 57.50/60 strangle. We are not able to confirm the order flow of this position, which would have traded on a combined premium of $8.35 – fully 14% of the current share price.

This rich premium, fortified by the fact that implied volatility in ProLogis options is showing its largest disparity against the historic reading on the stock in two months (the market is looking for 31% more risk to ProLogis shares over the next 30 days), could be a powerful inducement to a seller of premium who believes that ProLogis shares will remain bound between the $2.50 range of the strike prices. Over the past 6 months, shares have traded as low as $51.66 and as high as $69.14. Selling the strangle would predict stagnant share price action around current levels into the fall.

Rebecca Engmann Darst contributed to this report.