An Update on an Income Play

In late spring of this year we devoted an issue to Healthcare REITs. We attempted to make the case that healthcare REITs blend two excellent asset classes—real estate and healthcare. The space usually owns or leases out medical office buildings, senior living facilities, acute care facilities and hospitals. They collect the rents and pass on the income to shareholders. We featured Welltower and Ventas in the issue and took positions in both… one in the ISAW dividend portfolio and the other in our regular personal holdings portfolio. Our philosophy has always been to eat our own cooking. At the right price, we will own everything we write about.

We bought a few shares of Welltower (HCN) at $75 and at the time it had a dividend yield of approximately 4.7%. But we added a little twist to the position by selling call options against our stock. We sold the December 75 call options for $3.00 (or $300.00 since each option is an obligation on 100 shares). Selling call options is a way to generate additional income from your stock holdings. The buyer of the 75 call has the right, but not the obligation, to own 100 shares of HCN at a price of $75 anytime between purchasing the option and the third Friday of December when it expires. The seller of the option (me!) has the obligation to deliver 100 shares for each option written at 75 if the buyer exercises his right to do so. The strategy is called covered option writing since I own the underlying shares. If I didn’t own Welltower, then it would be a naked write strategy which is riskier. If they are at 75 or above by expiration, the call buyer can exercise his right and “call” my shares away at the strike price of 75. Ideally, you want the stock to remain stable and trade in a narrow range. Then the premium, because of “time decay” as expiration nears, shrinks. I sold the call for 3.00 ($300.00) and it’s now trading at .35 ($35.00). HCN has drifted slightly lower and trades at about $70.28. I paid $75 for HCN stock.

At his point, the following can happen:

  • If HCN is below $75 at the December expiration I would pocket the entire premium despite having a loss in the stock. The premium would help offset any loss I might have on paper. Over the long run, I look for HCN to advance and provide a nice profit.
  • I could buy back the option and book a $265.00 profit and sell another option 3-6 months out.
  • Should the stock rally sharply above $75 in the next few months, the stock will be exercised and I would lose my shares at $75.00…exactly what I paid for them. But I would collect the premium–$300.00—and two dividend payments totaling $178.00 for a grand total of $478.00 for each 100 shares owned. Given that I paid $7500.00 for each 100 shares back on June 14th, my return if “called away” would be 6.4 percent in a little over 6 months. Better than bonds, money markets and CDs and many other fixed income investments.

So far so good. But if interest rates were to climb appreciably, the whole REIT sector would suffer a bit and I would risk further declines in the stock. But over the intermediate and long term, REITs have done superb. Their only blemish was during the financial crises when they lost more than half their value along with the rest of the market. For those with no experience in options, we strongly urge you to work with a financial professional who can guide you through some of the complications associated with options.

Do your homework.

Dave Lerman / Jodie Warner

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