Managing Trades

I was seduced against my better judgment. On February 23, I sold some puts on Annaly Capital Management (NLY) with a strike of 14. It is a mortgage REIT that trades Fannie Mae mortgage pass throughs and earns the difference between its funding cost and the interest earned on the mortgage notes. It is also leveraged about eight times, so that magnifies the returns. Since the Federal Reserve is making a market in these issues, they are almost guaranteed. Since it is a REIT, it has to pay out at least 90% of what it earns to shareholders to get favorable tax treatment.

So my idea in the last week of February was to sell the puts and perhaps have NLY put to me in time to get this quarter’s interest payment. This is only a good idea if the stock does not fall too far. There is no point getting 1.3% interest if the stock falls 10%. That is a bad trade.

Sure enough, on 6th March, NLY was trading around $12.50. Not wanting to lose any more on the trade, I saw the delta on the puts was -.8 and I sold about half that in stock. That is, for the 10 puts the equivalent stock was 800 shares so I sold 500 short. Not quite matching the delta, but stopping the bleeding.

Today, the market was up over 6% and NLY was up 7% to 13.90 near the 14 strike. I wasn’t thinking about my position going from net long 300 equivalent shares (delta of the 10 puts .8 => .8 * 10 * 100 = 800 – 500 shares that I am short) to net flat. Since the puts have a delta now of near -.5 that is equivalent to 500 shares and I am short 500 shares.

That is OK. Tomorrow, if the market continues to rise, and it closed on its high of 719.60, I will become net short if NLY continues to rise also and its delta continues to drop. Then I will have to adjust my position.

I did the same thing with Hatteras Financial, another mortgage REIT. They trade the shorter term mortgages which matches their funding more closely. So HTS trades less wildly than NLY.