Canadian real estate has rallied tremendously since its March low, gaining over 70% in the period to date. In just the past week, the S&P/TSX Capped Real Estate index advanced 5%. The share prices of companies like Brookfield Properties (TSX: BPO) have doubled in the period.

Surprising really, given that many analysts are predicting a commercial real estate meltdown in the US, which could be larger than the residential real estate bubble. More than a few pundits have been scratching their heads why we have seen such strength in the Canadian market. Could it be irrational exuberance?

Investors may be rightly concerned that the rally in real estate is becoming a bit stretched, and could be ripe for a bout of profit-taking. Or conversely, a period of consolidation where the market digests recent gains.

If so, aggressive traders could look at buying puts on optionable stocks like Brookfield Properties (TSX: BPO, recent close $12.44) to profit from any potential correction. For example, buying the BPO Jan 12 puts at $1.15 would be one potential strategy to profit from a correction. You could also trade puts on Brookfield’s parent, Brookfield Asset Management (TSX: BAM.A, recent close $25.32).

Less aggressive traders who want to maintain a position in this sector might look at writing covered calls. The sale of covered calls will reduce the downside risk, although it will not provide the same dollar for dollar bang you would get from buying puts. Still the additional cash flow from the sale of covered calls will help, especially if the Canadian real estate market goes through a period of consolidation rather than experiencing a correction.

For covered call writers, look at selling the BPO Jan 13 calls at $1.00. Or for BAM.A, write the Jan 25 calls at $1.90.