Not everyone had enough cash or borrowing capacity to buy an investment property.
Those that do have issues with collecting rent, broken toilets, damaged properties etc. etc.
Luckily, using options, there is a way to gain exposure to the real estate market without having to put up any cash (or at least very little).
Don’t worry, I’m not some crazy real estate spruiker trying to sell you some shady deal.
Today, I’m going to show you how I use stock options to gain exposure to the real estate market without ever having to deal with a dodgy tenant or property manager.
REAL ESTATE INVESTMENT TRUSTS
Real estate is an essential asset class for all investors, but there are some headaches involved.
You’re drawn to the passive income and capital gains. But you’re wary of the lack of liquidity, the operational challenges (chasing tenants down for rent, the ongoing repair and maintenance, etc.), and the amount of capital that is required to get into the game. What do you do?
According to NAREIT, the National Association of Real Estate Investment Trusts:
“REITs, or real estate investment trusts, are companies that own or finance income-producing real estate in a range of property sectors. These companies have to meet a number of requirements to qualify as REITs. Most REITs trade on major stock exchanges, and they offer a number of benefits to investors.”
The are hundreds of REIT’s trading on the US stock market of which some of the most popular are:
WPC – W. P. Carey Inc.
SPG – Simon Property Group
NRZ – New Residential Investment Corp.
O – Realty Income Corporation
OHI – Omega Healthcare Investors, Inc.
LTC – LTC Properties, Inc.
Another way to gain a diversified exposure to REITS is via iShares US Real Estate ETF – IYR.
The top 10 holdings within IYR are:
AMT – American Tower Corp
SPG – Simon Property Group Inc
CCI – Crown Castle International Corp
PLD – Prologis Inc
EQIX – Equinix Inc
PSA – Public Storage
WY – Weyerhaeuser Co
EQR – Equity Residential
AVB – AvalonBay Communities Inc
DLR – Digital Realty Trust Inc
While the yield on IYR is a little lower than some of the individual REIT names, I really like it because you get a diversified exposure to the real estate sector.
IYR currently yields around 3.82% and has very liquid options.
POOR MAN’S COVERED CALL
Investors wanting to own 100 shares of IYR would need to shell out around $7,900. That’s a pretty hefty some and not everyone has that kind of cash lying around.
Today, I’m going to show you a strategy that produces similar returns for a fraction of the cost AND it has the added benefit of increasing the income potential of the investment.
A Poor Man’s Covered Call is a strategy designed to replicate a standard Covered Call trade, but with a much lower capital outlay. Therefore, it can be a great strategy for those with limited capital, but there are risks involved which I’ll talk about shortly.
Let’s look at a sample trade setup:
Trade Date: February 27, 2018
Buy 1 Jan 17th, 2020 65 Call @ $9.20
Sell 1 June 15th, 2018 77 Call @ $1.08
Spread Price: $8.12
Net Cost:$ 812
In this example, instead of having to come up with $7,350 to buy 100 shares of IYR, we only have to come up with $812 and this is the most we can lose, even in the unlikely event that IYR goes to $0.
Buying an in-the-money call option at $65 is a cheap way to control 100 shares of the underling. Because this call option is in-the-money it will perform very similar to 100 shares of the underlying.
In addition to this, we’ve sold an out-of-the-money call option to generate some income potential and offset some of the cost of the long call.
By selling the June call out-of-the-money, we’ve allowed ourselves some room for capital appreciation.
Let’s roll forward to June 5thand see how the trade is doing.
IYR has experienced a nice run up in price, moving from $73.51 to $79.15.
The $65 call that we own has gone up from $9.20 to $14.15 and the June $77 call that we sold has gone from $1.08 to $2.28.
Therefore, we have a gain of $495 on the long call and a loss of $120 on the short call for a net position gain of $375.
Our initial capital at risk was $812, so our return in percentage terms is 46.18%. Not bad for a three and a half month trade where the underlying ETF has only risen 7.67%.
There are risks involved in this type of trade. We’re basically using options to gain a leveraged exposure to IYR. The ETF could just as easily have declined during this period leaving us with a large percentage loss.
Traders with short call options can be exposure to early assignment risk, particularly if the short call goes in-the-money and there is an ex-dividend date on the horizon.
Buying an in-the-money call option means the investor does not receive any dividends whereas an investor buying the ETF directly would.
By using options we’ve gained exposure to the real estate market for very little cost and achieved a nice return in a short period of time.
Poor man’s covered calls are a low cost way for traders to take an opinion on an underlying stock or ETF while also generating some income from selling options.
If you want to check out a detailed example of an IYR poor man’s covered call that played out over the course of a year, you can do so here.
Disclaimer: The information above is for educational purposes only and should not be treated as investment advice. The strategy presented would not be suitable for investors who are not familiar with exchange traded options. Any readers interested in this strategy should do their own research and seek advice from a licensed financial adviser.