The Volatility Trader
105 W. Monument Street
Baltimore, MD 21201
Thursday, December 7, 2006
Email – #232
Time To Short Commercial REITs Again
Dear Volatility Trader Member,
Last time we attempted to short a REIT (Real Estate Investment Trust), it didn’t quite work out as we planned. If you remember, we owned Equity Office Property puts, which we’ll let expire worthless in the wake of the company making a surprise announcement that it will be bought out and taken private.
But around midnight last night, having pored over about 500 charts, I kept coming back to the REIT sector. There was something compelling about them that I couldn’t ignore.
The way the REITs are overbought is signaling a significant pullback.
I think the most recent push higher is solely due to money being reallocated from Canada, given the recent oil trust taxation news. But on a fundamental level, the stocks simply don’t support current levels. And while it’s true that the dividend payouts to shareholders are steady, the premiums paid for the stocks don’t justify those payouts.
However, with these stocks at current levels, it presents us with an incredible opportunity to make a ton of money, so let’s grab this trade:
Buy the Vornado Reality Trust January $125 puts (VNO-ME) for no more than $2.80.
IMPORTANT: This is a low volume option, and the spreads are very wide. Right now, the option is trading at $2.55 by $3.10. This means that if you put in a market order, you’re going to have to wait for the option to gain $0.55 in value before you break even. So don’t use a market order. Don’t pay more than $2.80… and when you put your order in, it may take a while to get filled.
We will not mark the position in the Volatility Trader portfolio until I see some activity at $2.80, indicating that subscribers are able to get filled.
Here’s what you need to know:
While the underlying stock is currently trading at $125, the 50-DMA is trading near $116, and the 200-DMA is around $101. If this stock corrects to the 200-DMA in the next 5 weeks, there could be over 20 points in upside potential for this trade. It would be a whopper, but it is very risky, so perhaps scale back on the amount of contracts you buy, in relation to what you normally do.
On the other hand, it’s possible that the stock could spike again – and if it does, our option could go to zero. But we won’t sell it, because when the sell-off in these stocks comes, it will be very sharp. We’ll hold the option to expiration on Friday, January 19 (unless of course it buckles before then).
There are more reasons why this trade makes sense:
Fundamentals: First, the stock trades with a P/E ratio of 37 and a forward P/E of 23. More importantly, though, the PEG ratio is 3.3, while price to sales is 6.1. These numbers are exuberantly high for any stock. Remember the dot.com “new economy” days? Well it’s happening right now in commercial real estate, and let me tell you… just like the dot.bombs, the REITs are due for a shakeup.
What’s more, Vornado has an almost 18 billion market cap, with only $2.9 billion in revenue. The company also just raised $1 billion in cash to buy more property, but beforehand, it only had a little over $355 million on the books. This REIT is overleveraged, and any hiccup could spell disaster for shareholders.
And if the company makes any mention of a dividend reduction, value investors will flee the stock faster than bees when a hive is on fire.
Technicals: The daily chart (not pictured here) is trading with the MACD 26-day line poised to cross under the 12-day, at the very top of the range. This is bearish.
But the weekly chart is what we’re interested in. Take a look at it below. You’ll notice the stock is up significantly over the last year – about 55%. What you can’t see though, is that the stock is up 150% since 2004.
On a weekly basis, slow stochastics have been topped out for five months. Rarely have I seen this occurrence. But when I have, the stocks have crashed and burned.
What’s more… one of my favorite and most reliable technical indicators is showing an interesting development. It’s called “Andrew’s Pitchfork” and is a simple trend tool that allows us to predict where a stock will move to, once a trend is in place.
And as you can see in the chart above, the current trend began over a year ago, and finally hit the very top of the pitchfork just this week. I could not be more excited about a technical event!
Exit is everything,
Mark Whistler
