By Greg Jensen
In the grand scheme of things, there are obvious reasons to buy healthcare REITs. Income from hospitals and residential care facilities looks set to keep increasing due to an aging population. In the long term, things look great; in the short term, not so much.
As our politicians dance on the edge of the fiscal cliff, the market hesitates. The risks to the overall economy, should there be no agreement, are well documented. Certain industries, such as defense, are expected to suffer disproportionately, whether an agreement comes before or after the deadline.
Healthcare is different. Traditionally, the sector is seen as fairly recession proof; we don’t stop getting sick because of negative GDP growth.
The potential problem for many healthcare sector REITs in particular, however, is that the properties they own are increasingly dependent on government money. According to an article in Businessweek, hospitals receive around $450 Billion, just under half of total revenue, from Medicare and Medicaid. Nursing homes get around $89 Billion, or 55% of their total, from government programs.
As negotiations heat up, both sides of the political divide would like to preserve healthcare benefits for the electorate, but cuts must be made. It would seem to be only a matter of time before a proposal to significantly cut provider reimbursement is floated. This belief, combined with scheduled cuts should we go over the cliff, has put a damper on previously buoyant healthcare REIT stocks. The six month charts for Healthcare REIT, Inc. (HCN), HCP, Inc. (HCP) and Senior Housing Properties Trust (SNH) shown below, tell a similar story, with around 5 months of little direction stopping an upward trend.
HCN 6 Month
HCP 6 Month
SNH 6 Month
Once an agreement on fiscal matters is reached, and eventually it will be, something will happen. The obvious question is what? If payments to providers and eligibility for healthcare programs are both cut, these stocks could plummet. If, on the other hand, Medicare and Medicaid escape relatively unscathed, there could be a significant relief rally. Either way, a basic option strategy could be the answer. A strangle has a naturally limited downside (the maximum loss is the total of premiums + commissions) with an unlimited potential upside in the event of significant movement in either direction.
As an example, let’s look at HCN. At the time of writing the stock is trading at around $59. January 2013 expiration $62.50 calls last traded at $0.20 per share and the January $55.00 puts at $0.30.
Buying equal amounts of each would therefore cost $0.50 per share. (If you are new to options you should know that they are traded in 100 share contracts, so the minimum investment would be $50.) Your break even points (ignoring commissions) would therefore be $63 should the stock go up, and $54.50 should it go down. If HCN closes anywhere inside that range at expiration (January 19th 2013) you lose all of your $50 per contract. If it breaks out, you begin making money and the further it moves the more you make.
This is not a specific trade recommendation , just an example. The point is that sometimes, as with healthcare REITs right now, it is logical to assume that a move will happen, but hard to assess in which direction. For most traders and investors this is a signal to avoid the stock. For those with a knowledge of options, however, it is just another opportunity to consider.