A Real Estate Trade Offering a Possible Short-Term Gain of More Than 50%
Trade summary: A bull call spread in Safehold Inc. (NYSE: SAFE) using the November $70 call option which can be bought for about $3.90 and the November $75 call could be sold for about $1.95. This trade would cost $1.95 to open, or $195 since each contract covers 100 shares of stock.
In this trade, the maximum loss would be equal to the amount spent to open the trade, or $195. The maximum gain is $305 per contract. That is a potential gain of about 56% based on the amount risked in the trade.
Now, let’s look at the details.
SAFE reports that the company “is revolutionizing real estate ownership by providing a new and better way for owners to unlock the value of the land beneath their buildings. Through its modern ground lease capital solution, Safehold helps owners of high quality multifamily, office, industrial, hospitality and mixed-use properties in major markets throughout the United States generate higher returns with less risk.
In the most recent quarter, SAFE posted revenue of $38.0 million, a 70% increase compared to the same three months in 2019. Net income of $14.2 million represented a 159% year-over-year increase.
Earnings per share increased 84% compared to the same quarter a year ago, reaching $0.28. The company also reported $105 million of new investments, including $71 million closed subsequent to the end of the quarter and over $200 million of signed letters of interest.
Subsequent to the end of the quarter, SAFE added new bank relationship to revolving credit facility and upsized by $32.5 million
“Amid the ongoing disruption caused by the pandemic, Safehold is beginning to witness a recovery in commercial real estate transaction activity,” said Jay Sugarman, Chairman and Chief Executive Officer.
“With a significant war chest ready to be deployed, we are excited to see a growing near-term pipeline as Safehold continues to expand and deliver modern ground lease capital to customers in high-quality markets across the U.S.”
The news pushed the stock out a trading range.
The longer-term chart shows that the trading range extended back to the end of 2019 and followed a significant rally in the stock. There is now significant support near $65, the top of the trading range, which should limit risk. A break of that could lead to a decline of $15 or more since the next important support level is near $50.
Stochastics and MACD, popular momentum indicators, confirm that the breakout could deliver more gains. While bullish momentum could decrease risk, it does not eliminate risk. A spread trade, while also unable to eliminate risk, can limit risk to a precise level.
A Specific Trade for SAFE
For SAFE, the November options allow a trader to gain exposure to the stock. This trade will be open for about six weeks and allows for traders to turn over capital quickly, potentially compounding gains several times a year.
A November $70 call option can be bought for about $3.90 and the November $75 call could be sold for about $1.95. This trade would cost $1.95 to open, or $195 since each contract covers 100 shares of stock.
The amount paid to enter the trade is the largest possible loss on the trade. This is generally true whenever a trader is creating a debit to enter an options trade. “Creating a debit” means there is a cost to enter the trade. You could create a debit by simply buying puts or calls to open a directional trade.
In this trade, the maximum loss would be equal to the amount spent to open the trade, or $195.
The maximum gain on the trade is equal to the difference in exercise prices less the amount of the premium paid to open the trade.
For this trade in SAFE, the maximum gain is $305 ($75- $70= $5; 5- $1.95 = $3.05). This represents $305 per contract since each contract covers 100 shares.
Most brokers will require minimum trading capital equal to the risk on the trade, or $195 to open this trade.
That is a potential gain of about 56% based on the amount risked in the trade. The trade could be closed early if the maximum gain is realized before the options expire.
A Trade for Short Term Bulls
As with the ownership of any stock, buying SAFE could require a significant amount of capital and exposes the investor to standard risks of owning a stock.
To reduce the risks of a trade, an investor could purchase a call option. This allows them to benefit from upside moves in the stock while limiting risk to the amount paid for the options. However, buying a call option can also require a significant amount of capital and includes the risk of a 100% loss.
Whenever an option is bought, the maximum risk is always equal to 100% of the amount of spent to purchase the option. Since options cost significantly less than a stock, the risk in dollar terms will be relatively small to own an option.
To further limit the risks of the trade, an investor could use a bull call spread. This strategy consists of buying one call option and selling another at a higher strike price to help pay for the cost of buying the first call. The spread strategy always reduces the risk of an options trade.
This strategy is designed to profit from a gain in the underlying stock’s price but the benefit of avoiding the large up-front capital outlay and downside risk of outright stock ownership. The potential risks and rewards of this strategy are summarized in the chart below.
Source: The Options Industry Council
Both the potential profit and loss for the bull call spread are limited. The maximum loss is equal to the net premium paid when the trade is opened. The maximum profit is limited to the difference between the strike prices, less the debit paid to put on the position.
This strategy could be especially appealing with high priced stocks where the share price and options premiums are often a significant commitment of capital for smaller investors.