Make This Easy Trade To Profit From Stalled Real Estate Prices

| October 26, 2018 | 0 Comments

Investing has come a long way from the days when it was just a simple choice between stocks and bonds. Typically your portfolio consisted of some mix of stocks and bonds (60%/40% stock/bonds was a pretty standard mix – and still is in some cases) with the only decision being how much to change the weighting based on market conditions.

That’s not to say that investors always avoided complex choices. There were always plenty of stocks to choose from if you didn’t want to buy an index fund.  Investors could get into the details of optimal diversification between a basket of stocks. (Bonds were pretty much restricted to Treasury securities.)

But it’s clearly a different world today. The adoption and widespread success of ETFs has made it extremely easy to invest in a variety of asset classes. These days, it’s more of a decision on what asset classes to invest in (and how to weight them) rather than what individual assets to buy.

For all intents and purposes, it’s just as easy to buy emerging market government bonds as it is to buy large cap US stocks. Plus, ETFs make investing in areas like commodities and real estate much simpler (REITs also serve a similar purpose for real estate investors).

Still, despite the multitude of choices for exchange traded real estate products, it is one area where plenty of investors still like to own the actual assets – that is, they like to buy houses and condos and rent them out. Frankly, I don’t understand it. Why go through the trouble of buying homes (cumbersome at best) and then manage the properties or pay someone to manage them for you (expensive and/or time consuming)?

Personally, I’m happy to invest in an ETF or REIT and let someone else do all the work. But, I get that property investment is a popular way to diverse asset classes. I understand that many investors prefer to navigate the real estate market rather than the stock market.

Here’s the thing…

Just because you invest directly in real estate doesn’t mean you need to ignore real estate ETFs. In fact, they can especially make for a great way to hedge your exposure to the real estate market. Property owners have the same price risk as any other asset holders – and their assets are often far more illiquid than exchange traded instruments.

As a matter of fact, a huge investor just bought a massive amount of puts on the Vanguard Real Estate ETF (NYSE: VNQ). VNQ is one of the most popular real estate ETFs (trading about 5 million shares per day on average) and tracks an index of REITs. Because VNQ tracks the real estate market, buying puts on it is a good way to hedge long exposure to real estate (such as owning property).

Now obviously VNQ isn’t necessarily going to correlate exactly to housing prices in your area if you only own property in one spot or region. However, any major moves in the real estate market as a whole will be reflected in VNQ’s price.

With VNQ at roughly $76.75, someone bought a whopping 66,000 72 strike puts expiring in January. At a price of $1.17 per option, this trade cost $7.7 million dollars. That’s obviously a substantial capital investment. Breakeven for this trade is $70.83, and anything below that by January expiration is profit. Max loss is the amount spent on premium.

VNQ

Buying puts roughly 10% below the current price about 3 months out strongly suggests that it’s a put hedge. Another reason I believe it’s a hedge is the trade was very clearly rolled from December (76 strike). By the way, VNQ basically just dropped 10% over the last month (from about $84 to $76) – so the last hedge probably worked very well.

While VNQ may not be a perfect hedge for property owners, it’s a quick, easy, and cheap method to protect at least some of exposure to falling property prices. In fact, buying the VNQ January 72 puts for around $1.17 is a very reasonable way to buy yourself protection if real estate gets hit for another 10% drop or more before next January. With the potential for higher interest rates looming, it could be a very good time to place this hedge.

 

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Category: Options Trading Strategy

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Jay Soloff is an options analyst with Investors Alley.

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