Profit from the break out in real estate

Tags: DRN, REITs, bull-call credit spread

Figures released this morning showed that the sales of new homes rose much more than expected: 300k vs 280k. This may be the impetus behind many REITs hitting new highs today. Along with them, the DRN, the Bull Real Estate ETF (whose top holdings includes REITs)–also hit a new all-time high, breaking minor resistance at $71.

The chart of the DBN (see below) shows support/resistance levels spaced about $8 apart. Using $71 as the current support level gives a price target in the $79-$80 range.

Stock Play: One way to play this is to just buy the stock at the current price of $73.60. If the stock reaches $80 (say), you’ll make a total profit of $6.40 or a 8.7% return on investment (ROI).

Option Play: Another way to play it would be to buy calls. Since the summer doldrums are approaching and the stock could stall, it’s wise to consider options with longer-term expiration dates.

Let’s look at the August 70/80 bull-call debit spread.

Here, you’d buy the lower stike call currently going for around $8.60. To lower your cost basis, you could also simulataneously sell the August 80 call for around $4.00. Your total cost for this transaction would be $4.60 per contract. Your total maximum profit would then be $5.40. This assumes that the stock will be at or above $80 (the higher strike price) at or before August expiration. In this case your return would be 117% which is a lot higher than your return had you just bought the stock.

Your trade-off is that you could potentially lose all of your investment should the stock trade below $70 at expiration. The point at which you begin realizing a profit is at $74.60 (the lower strike + the cost of the spread). Also note that these options are rather thinly traded: the open interest on the August 70 call is 124 and only 11 for the August 80.  In illiquid markets, it’s best to hold out for your spread price. Just remember to give yourself time to unwind the position as it could be tough with thinly traded options.

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