Recent Option Transaction

Since reaching a new high of $55.48 earlier this month, Realty Income (O) has sold off almost 16%  over the last 1.5 weeks.  The selloff started thanks to concerns about possible rising interest rates which I don't foresee happening anytime soon.  As long as rates don't jump higher then there shouldn't be much risk towards Realty Income's business.  Here's a snapshot of Realty Income's operations taken from their website.

"We purchase commercial real estate for cash leased to tenants that have a good business and operating track record. The leases are typically for 15 to 20 years, which provides us with dependable lease payments each month that are used to support monthly dividend payments to our shareholders."


I've been wanting to get some exposure to real estate and I much prefer equity REITs as opposed to the other flavors because they actually own the underlying real estate.  Essentially they are a landlord which I wouldn't mind getting into but you just can't get the diversification as easily on your own as you can through purchasing shares of an equity REIT such as Realty Income.  My Financial Independence Journey has a great post discussing the differences between the types of REITs and if you're looking for more information on the subject I recommend stopping by there.

Anyways, on to the trade.  On Thursday, May 30th I sold a $45 put option for $2.90 that expires on December 21, 2013.  After commission and fees I received $281.26 in option premium.  This trade can work out one of three ways.

(1)  If O is trading above $45 on expiration, then I will get to keep the full option premium as profit. This would be a $281.26 / $4,500 = 6.25%.  This would be annualized to a 11.13% return through expiration.

(2)  If O is trading below $45 on expiration, then I will be forced to purchase 100 shares of O for $45 each.  Since I received the option premium I get to back that out from my cost basis which would then become $45 - $281.26 / 100 + $7.95 / 100 = $42.27.  Based on the current annual dividend rate of $2.17 per share, these shares would carry a YOC of 5.13% and would provide $217 in annual dividends.

(3)  If the share price of O rebounds between now and expiration, I can buy to close the put option early for a return less than in case 1.

I really wanted some real estate exposure and was comfortable owning shares of Realty Income around $42.  Selling the put option gives me the best of both worlds where I can either own some shares of a wonderfully managed REIT or earn a great return if the share price doesn't retreat further.  Earlier this month I felt that O's share price had gotten ahead of the value of the business so I had to wait for a better opportunity.  My purchase price of $42.27 will give a higher yield than what is currently being offered on shares of O and I feel will be set up for solid returns going forward.  The projected total return going forward would be approximately the yield plus dividend growth.  Based on my purchase price this would be 5.13% + 3.5% = 8.63% with a conservative 3.5% dividend growth rate.

I sold this put on margin as well which allows me to set aside much less capital to secure the put.  Instead of the $4,500 for a cash-secured put, I'm only required to have $1,213 to satisfy the margin requirements.

Dividend Monk has a great analysis on Realty Income and I highly recommend you check it out if you're interested in learning more about O or REITs in general.

I've updated my Option Summary page to reflect this trade.