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REITS: Good Covered Call Writing Candidates? A Real-Life Example with PennyMac Mortgage Investment Trust (NYSE: PMT)

REITs (real estate investment trusts) invest directly in income-producing real estate and is traded like a stock. In September 2019, Clifton wrote to me about inquiring if it would make a viable covered call writing candidate. He pointed out that this security offered an 8.5% annualized dividend yield. To evaluate, we will examine the price chart, and calculations to make an educated assessment.

Price chart of PMT versus the S&P 500 from 2014 – 2019

In this 5-year time-frame, PMT substantially under-performed the overall market (S&P 500), 3% compared to 49%.

 

5-week option-chain for PMT ($22.33)

 

A 5-week premium of $0.15 represents a return of 0.67%, 7% annualized. Each investor must decide if this return meets their financial goal.

 

Advantages of PMT

  • Relatively safe security
  • Significant 8.5% dividend yield
  • Real-estate component to portfolio diversification

 

Disadvantages of REIT PMT

  • Low volatility stock (Beta is 0.54) offers low option premiums
  • Substantially under-performs the S&P 500 over a 5-year time-frame

 

Skills required

 

Discussion

REITs like PMT may be appropriate for some investors who are looking to diversify into real-estate and generate a modest option-selling return along with a significant dividend yield in return for potential profit from share appreciation offered by the overall market.

 

Your generous testimonials

Over the years, the BCI community has been incredibly gracious by sending our BCI team email testimonials sharing stories as to what our educational content has meant to their families. Moving forward, we have decided to share some of these testimonials in our blog articles. We will never use a last name unless given permission:

Hi Alan,

I’ve recently discovered your website while looking for information on covered call strategies, and first of all, I want to thank you for this incredible amount of insightful information and all the effort you have put into this site.

Leo

 

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About Alan Ellman

Alan Ellman loves options trading so much he has written four top selling books on the topic of selling covered calls, one about put-selling and a sixth book about long-term investing. Alan is a national speaker for The Money Show, The Stock Traders Expo and the American Association of Individual Investors. He also writes financial columns for both US and International publications along with his own award-winning blog.. He is a retired dentist, a personal fitness trainer, successful real estate investor, but he is known mostly for his practical and successful stock option strategies.

17 Responses to “REITS: Good Covered Call Writing Candidates? A Real-Life Example with PennyMac Mortgage Investment Trust (NYSE: PMT)”

  1. Angie May 9, 2020 4:12 am #

    Hi Alan –

    Thanks so much for your assistance and expertise! I purchased the PMCC calculator and the advanced strategies book. I’ve also watched the Blue Hour on PMCC and the area I’m struggling with is the trade management.

    I’m paper trading KO and I ended up closing the short leg because of the 20% rule. I understand TM techniques, but when I plug everything into to the short call next month tab, how do I decide if the new short position is a “good” one? If I just stay out of the money? Is there a TV credit % I’m shooting for?

    Thanks for any guidance you can give. 😉 Or if you can point me to a place where you’ve explained the calculator already…

    Hope you’re doing well!
    Angie

    • Alan Ellman May 9, 2020 7:06 am #

      Angie,

      If the short call is expiring in-the-money, we can use the TM-Short Call Next Month tab to evaluate returns on rolling out to 2 new (or same) strikes for the next contract month. See the screenshot below). The return goals vary from investor-to-investor but we generally use out-of-the-money strikes based on current market value of the stock at the time we are rolling the short call. Since we are using the PMCC strategy rather than traditional ccw, our goals are significantly higher. To identify your goal, use a strike that would return (say) 2% – 4% per month based on the value of the stock at the time of the trade. The PMCC Calculator will translate that return based on the cost of the LEAPS option.

      Use the TM- Short Call Current Month when rolling options up or down in the same contract month.

      If the short call expires worthless, start over with the Initial Trade tab.

      When you purchased the PMCC Calculator, you received a user guide explaining all tabs. If you need a replacement, send me a direct email and I’ll get it over to you.

      CLICK ON IMAGE TO ENLARGE & USE THE BACK ARROW TO RETURN TO BLOG.

      Alan

  2. Terry May 9, 2020 3:36 pm #

    Fun fact…Nasdaq is now positive for the year, QQQ ytd performance is up 6%.

    Best;
    Terry

    • Jay May 10, 2020 10:00 pm #

      Hey Terry,

      I saw that too. Plus Trump trotted out his “Bull Boy” Kudlow today to talk about the next wave of stimulus on the morning show. Larry K was the fall guy touting Trump’s “buy the dip” message heading into the virus and took beatings for that. My hunch is he is reticent about getting torched again? So the market might go up on what he says?

      I therefore don’t want to be caught holding bearish covered calls this week. I have some bullish OTM csp’s for Friday so we shall see how it works out? A great trading week to all. – Jay.

      • Terry May 11, 2020 9:04 am #

        Hi Jay;

        I love it when a plan comes together. CC’s into strength and CSP’s into weakness.

        Good luck;
        Terry

        • Jay May 11, 2020 10:27 am #

          Thanks and good morning Terry!

          I suspect Alan has said it a thousand times but there is no “one size fits all” in this game :)?

          My personal preference is to use covered calls defensively selling them on up days on things I hold that I am neutral or leery on for the moment. I love selling csp’s on down days on the things I want more of! But that is just me…

          Since commissions went away I find myself doing more one and two week expirations for better flexibility. – Jay

  3. Marcus May 9, 2020 3:41 pm #

    Alan,

    I am reading your book right now, and I have a question for you. When you look at fundamentals, there are so many of them to choose from. How do you choose which ones are most important, and what numbers do you use to weed out the stocks? For instance, what MAR and PEGY numbers do you use for your cut off?

    When I start plugging in some of your numbers for stock screens, very few, if any, stocks come up.

    Thank you.

    Sincerely,
    Marcus

    • Alan Ellman May 9, 2020 4:41 pm #

      Marcus,

      The PEGY ratio is the PE ratio divided by projected growth + dividend yield. It is one among many ratio valuations that can be used for fundamental analysis. Generally, a PEGY ratio < 1 is considered a potentially good investment. See pages 47 - 54 in "The Complete Encyclopedia..." Volume II for a detailed discussion of ratio valuations. MAR has become a recent important addition to our BCI screening process. We include only stocks with MAR values of 3 or less. As far as the big picture for fundamental analysis is concerned, we use IBD SmartSelect screens, IBD 50, IBD Big Cap, CANSLIM stocks as well as our own database of stocks we have identified over the years as potential option-selling candidates. Stocks that pass these fundamental screens must then also pass out technical and common-sense screens. This 3-pronged screening approach is the basis for our BCI Premium Stock Reports. For those who do not want to become premium members, there are several free and paid services. A free one is http://www.finviz.com and investors can enter their preferred parameters to create a watch list.

      Alan

  4. Barry B May 9, 2020 8:44 pm #

    Premium Members,

    This week’s Weekly Stock Screen And Watch List has been uploaded to The Blue Collar Investor premium member site and is available for download in the “Reports” section. Look for the report dated 05/08/20.

    Also, be sure to check out the latest BCI Training Videos and “Ask Alan” segments. You can view them at The Blue Collar YouTube Channel. For your convenience, the link to the BCI YouTube Channel is:

    http://www.youtube.com/user/BlueCollarInvestor

    Since we are in Earnings Season, be sure to read Alan’s article, “Constructing Your Covered Call Portfolio During Earnings Season”. You can access it at:

    https://www.thebluecollarinvestor.com/constructing-your-covered-call-portfolio-during-earnings-season/

    Best,

    Barry and The Blue Collar Investor Team

    [email protected]

  5. Barry B May 10, 2020 1:25 pm #

    Premium Members,

    There was a sorting problem with the “Wkly Avail” column in the report uploaded last night. It has now been corrected. Please look for the report dated 05/08/20 – RevA. The sorting issue did not impact any of the pass/fail rankings.

    Best,

    Barry

  6. Mike May 11, 2020 2:43 am #

    Hi Alan.

    Hope all is well with you.

    Since the Covid-19 situation has taken hold, each week in the Weekly Stock Screen report you talk about utilizing a Delta Neutral strategy. I’ve copied your comments below from the March 21st blog posted titled Volatility and the Post-Crash Decade. While I think I conceptually understand that this is a risk reduction strategy, I’m not totally clear on the mechanics of executing these trades. I have the following questions if you would be kind enough to answer:

    1. Are you selling in the money Call options on both SH and the better performing SPDR’s? Do you already own these underlying’s or do you enter the transaction as a Buy-Write?

    2. How is the in the money Call strike price determined – a certain % away from the at the market price, a specific Delta on the Call options or are you simply trying to get a 1%-2% return based on BCI ETF guidelines?

    3. If there are equal dollar positions in the Inverse ETF and SPDR’s, theoretically couldn’t this turn out to be a zero sum result? In other words, if SH goes up say 5% the SPDR’s could correspondingly go down approximately 5%. I realize that the math doesn’t working out exactly that way depending on how each underlying moves e.g. in your ETF selections you might own GLD which actually goes up while other SPDR’s decline in price. However, with that said are you realizing incremental profit on these Delta Neutral type trades that is materially better than just being 100% in cash during this Pandemic market volatility?

    As always thanks for your insights and helping us BCI investors!

    Best regards,
    Mike

    • Alan Ellman May 11, 2020 7:09 am #

      Mike,

      My responses:

      1. The first month I used this approach, I used all ITM strikes. For the May contracts, I used a mix. Each contract month, I re-evaluate the SPDRs, and either retain or replace securities based on current performance.

      2. I first determine the “moneyness” of the strike and then select based on an initial time-value return goal range of 1 % – 2% (I use 2% – 4% when I use individual stocks).

      3. If the underlying securities cancel out, we have our option premiums as profit for the contract month. We must be diligent with our exit strategies to ensure the highest possible returns as the market bias may lean strongly in either direction.

      Each investor must decide how much cash they are willing to risk in these market aberrations. I have decided to implement this Delta-neutral portfolio concept to mitigate risk during these unusual times. I plan to return to a more typical approach when there is clarity on market direction.

      Alan

    • Roni May 14, 2020 1:33 pm #

      Hi Mike,

      I agree with you, and would like to state again that I am 100% in cash since the beginning of this terrible scourge and ensuing market volatility.

      My main reson for staying out, is that I cannot dedicate myself fulltime to watch my trades and execute the exit strategies immediately upon the fast movements of this market.

      Roni

  7. Walter May 11, 2020 4:54 am #

    Alan

    I read and enjoyed your book – Exit Strategies for Covered Call. I followed all the examples except for one. On page 119 you show the calculations for the MVL stock/option trade. My problem stems from my understanding that your calculation list is in chronological order. I am fine down to where on 11/21/08 the MVL contract is closed. However, on that same date after the market closed you list an additional Buy-to-Close and a Sell-to-Open contract.

    Question – if the market was closed, how were you able to make the last two option plays, were you trading after hours ?

    Walter

    BTW – I enjoyed your subtle humor – did you tell me you hit a triple 🙂

    • Alan Ellman May 11, 2020 7:31 am #

      Walter,

      The trades you are referencing on page 119 all took place on expiration Friday prior to market close. I do not trade after-hours.

      Prior to 4 PM ET, the $25.00 call was rolled to the following month as shown in the screenshot below.

      I do recall “hitting a triple”…they are few and far between but so much fun when those opportunities present.

      CLICK ON IMAGE TO ENLARGE & USE THE BACK ARROW TO RETURN TO BLOG.

      Alan

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