Trade Alert: The Oligopoly I Love to Hate
Of all the nickel-and-diming that occurs during a real-estate transaction, title insurance is one of the things I hate the most. But like most insurance products, you buy it with the hope that you’ll never have to use it.
The U.S. title insurance market is dominated by an oligopoly that’s about to shrink by one. In late March, FNF Group (NYSE: FNF)–perhaps better known as Fidelity National Financial–agreed to acquire Stewart Information Services (NYSE: STC) in a $1.15 billion cash-and-stock transaction that’s expected to close by the middle of next year.
If the deal can overcome regulatory hurdles, the title insurance market will then be largely split between just two companies–top-ranked FNF and No. 2 First American Financial (NYSE: FAF). With Stewart in the fold, FNF estimates its share of the title insurance market will climb to 41%.
Right now, the U.S. housing market is dealing with a shortage of supply for first-time homebuyers. That’s causing transactions to slow and overall volumes to plateau. Meanwhile, mortgage rates, though still low by historical standards, are rising.
We don’t yet have all the housing-market data in for the first quarter—we’re still waiting on most of the numbers for March, a month where winter-storm activity may have deferred activity in certain regional markets.
But we do know that existing home sales declined by 1.9% year over year, to 10.92 million during the first two months of the year, while sales of new homes rose by 2.1%, to 1.24 million.
Meanwhile, housing prices continue to rise, which could partly offset the potential drop in volume from a title insurer’s perspective.
The good news is that the housing market is highly seasonal, and the first quarter tends to be FNF’s weakest quarter of the year by far. In other words, expectations are already low for first-quarter earnings, which will be released on May 2. And that’s the only earnings report that will come out between now and the expiration of the option we’re selling today.
This trade will generate immediate income of $50 per contract now, with the possibility of buying FNF at an 8.2% discount to where it currently trades if the stock gets put to you. Investors should set aside $3,500 per contract sold to buy the stock in case the option expires in the money.
Regardless of how many contracts you sell, it’s absolutely critical that you follow the instructions below, particularly when it comes to setting the limit order.
How to Make the Trade:
- Trade: Sell to open the June 15, 2018, $35 Put on FNF.
- Allocation: Sell one put for every 100 shares you would be pleased to buy at $35 per share.
- Current Stock Price: $38.15
- Limit Order Price: a credit of $0.50 or more.
- Tell your broker: “I want to sell a put on FNF Group (NYSE: FNF) stock. Specifically, I want to ‘sell to open’ one June $35 Put for a credit of $0.50 per share or more.”
- Further Instructions Regarding the Trade:
- If the option price changes, you can adjust our recommended limit based on the midpoint of the bid/ask spread, which you should be able to see when entering the trade. Just make sure the potential credit is at least $0.50 per share or more.
- Place your limit order on a “good ‘til canceled” (GTC) basis and be patient.
The Win-Win Situation:
For every put contract you sell, you will collect $50 that’s yours to keep no matter what happens in the future.
If the put expires worthless, meaning the stock price is above $35 per share at expiration, then we’ll do another trade to create another instant payment.
If the stock is trading at or below the strike price upon the contract’s expiration, then you’ll be buying FNF at an 8.2% discount to the current market price, while locking in a yield of 3.4%—plus the premium you pocketed when you sold the put.
Then we’ll collect the dividend while creating more instant payments by selling covered calls against the stock.