As if political narratives were not creating enough unjust downward pressure on the price of this “healthcare” REIT (The Geo Group), Covid has intensified the pressure, and the shares are simply trading too low due to fear. Further, the fear has increased volatility which has led to very high upfront income opportunities in the options market. We review a specific trade that we believe is attractive today (and potentially into early next week), as long as the underlying stock price doesn’t move too dramatically before then.
The Trade: The Geo Group
Sell Put Options on The GEO Group (GEO) with a strike price of $10.00 (~10.4% out of the money), and an expiration date of August 21, 2020, and for a premium of at least $0.20 (this comes out to ~24% of extra income on an annualized basis, ($0.20/$10.00 x (12 months, annualized). This trade not only generates attractive income for us now, but it gives us the possibility of owning shares of big-dividend payer GEO at an even lower price if the shares fall even further than they already recently have, and they get put to us (and we’d be happy to own GEO, especially if it falls to a purchase price of $10.00 per share).
Your Opportunity:
We believe this is an attractive trade to place today and potentially over the next few days as long as the price of GEO doesn't move too dramatically before then, and as long as you’re able to generate annualized premium (income for selling, divided by strike price, annualized) that you feel adequately compensates your for the risks (currently 24%).
Our Thesis: The GEO Group (GEO)
Our main thesis is simply that politics and covid fears have caused GEO shares to sell off too far (the shares are priced to low). If you don’t know, GEO is organized as a REIT, and its main businesses is the ownership and operation of private prisons and detention centers. As we head into the 2020 election (just as when we were heading into the 2016 election) GEO is a political punching bag (Democrats want to largely abolish “for-profit prisons) and Republicans do not). Further, fears of COVID-19 have caused the entire real estate sector, including GEO, to face further downward pressure.
However, as we wrote in great detail in our previous GEO Group report, this is a business that is not going away. Sure, there have been decreased border crossings in recent months due to covid and tighter boarder security, but GEO ICE facility contracts “contain fixed-price or minimum guarantee payment provisions intended to ensure adequate staffing levels and consistent service deliver,” according to the company’s most recent quarterly call. Further, according to the call: “Currently our ICE processing centers in U.S. Marshals facilities are operating at around the capacity level tied to the fixed-price or minimum guarantee payment provisions.
Also, GEO’s Adjusted funds from operations (“AFFO”) last quarter was $0.55 per shares, more than enough to cover the $0.48 quarterly dividend. Even in a dividend reduction situtation, GEO will still keep pay a large dividend, and the upfront income on his trade is quite attractive.
Important Trade Considerations:
Please also keep in mind, options contracts trade in lots of 100, so to secure this trade with cash (in case the shares get put to you and you have to buy them) you’ll need to keep $10 times 100 on hand (the strike price times an options contract lot of 100). You’ll also need to be comfortable holding that many shares in your account from a position-sizing / risk management standpoint. Alternatively, if your account is approved for margin (borrowing) you don’t need to keep the cash on hand in case the shares get put to you, just know that if they do get put to you—you’ll buy them “on margin” and get charged the borrowing interest rate in your account (some investors are okay with this, others simply prefer to keep the cash on hand) if you don’t have enough cash in your account to settle up.
Two additional considerations when selling put options are dividends and earnings announcements because they can both impact the share price and thereby impact your trade. In this particular case, dividend payment are not an issure because GEO won’t go ex-dividend again until after this contract expires. However, GEO is expected to announce earning again around the end of this month, and this could add significant volatility to the share price. Nonetheless, given the high upfront premium income (and the already low share price), we are comfortable with this trade.
Conclusion:
The GEO Group’s financial performance has been consistent and dividends have grown as a result. Despite growth in dividends, political risks and covid fears surrounding this industry have severely compressed multiples and expanded the stock’s dividend yield to 17%. While we admit the stock is going to be volatile, we disagree with the low share price (the market is overly fearful). Plainly, Geo’s big dividend yield is worth considering, and if you are too risk-averse to pull the trigger on a normal buy order, you might consider this options trade instead because it allows you to generate very attractive upfront premium income (that you get to keep no matter what), and it also gives you a chance to own the shares at an even lower price if they fall further before expiration and get put to you. And at a price of $10/share, GEO is an extremely attractive long-term big-dividend investment.