Annaly Capital Management (NLY) Income Play With Options

I did one of my favorite options plays on this mortgage bond company structured as a REIT.  Annaly (NLY) buys pools of mortgages and borrows short term to fund them.  The flattening of the US yield curve has been a disaster for their earning and portfolio value the stock is down 27% in the last two years.  However, I feel this is the best managed and most transparent of all mortgage REITs.  I also feel that this REIT is fairly valued but would buy more at lower prices and am happy to sell and higher prices. 

So this seems to go against my general view that inflation and interest rates are going higher and it does.  However, this is a small position and it diversifies nicely my short bond futures position.  Also, this position benefits from a steepening of the yield curve.  Oh, and if I'm wrong? then yes, I'll own more of this REIT and mortgage bonds at a level where I am comfortable buying long term bonds and mortgages.

Thus, I did one of my favorite options strategies on an asset I feel whose value I understand and who's volatility is not oversold.

Bought NLY at $13.68
Sold NLY Jan 2008 12.5 strike puts at $0.95
Sold NLY Jan 2008 15.0 strike calls at $1.00

Crude Return Calculations (assuming $0.85 in dividends over holding period):

- Max Return NLY called at above $15. 35% (28% annualized*)

- Breakeven (Puts Excersized and I now have double the position) $10.88.  Losses below $10.88 are against double the initial position because the 12.5 strike puts were excersized. 

- Static Return (NLY stays right at $13.68): 24% (19.7% annualized*)

*Annualized returns calculated as raw straightline annualized return without accounting for dividend timing and assuming zero taxes.

Disclosures and confessions:  I own NLY.  (I am short Jan 2008 12.5 Puts and 15 strike calls on NLY.  This position benefits from declining interest rates, a fundamental view I do not hold. 

Disclaimer:  Nothing in this blog is meant to be specific financial advice or a recommendation to buy or sell.  I do not give investment advice.  Do your own research.  Do not rely on anything in this weblog to make investment decisions.  I do not log all my trades here. I only describe or mention those that I think might be interesting. Consult an investment professional familiar with your specific financial situation before buying or selling any security.