AT&T: Playing the Options

It is very tough to find stocks that you can invest in over a long period of time. Quite frankly, as we have witnessed, most companies are so poorly run that the companies don’t deserve long-term shareholders. However, I believe there are some businesses that are attractive on a long-term basis at the right price.

One of those businesses is wireless services. Specifically, I am looking at AT&T (T). Currently, the company trades for around $26 per share, giving AT&T a 150+ billion market cap. Most noticeably, AT&T sports a 6% yield at current prices.

Although the wireline business is facing some pressure, the wireless business is strong. At a $150 billion market cap, AT&T has generated over $10 billion in free cash flow over the past two trailing calendar years.

Like most people, I like to buy things cheap. In this case, I would love to buy AT&T at $17.50. That is a significant discount to the current price of $26, and assuming the dividend wasn’t cut, would give AT&T a yield of close to 9%.

The way I would play this is to write the January 2011 $17.50 puts for a premium of $.90 each. In other words, I would collect $90 per contract in premium. In return, I have the obligation to buy AT&T at $17.50 should the price ever reach that level between now and January 2011.

Let’s be honest. AT&T has a very remote chance of hitting $17.50. That would be ok – I would get to keep all my premiums should the stock never reach that level. If AT&T hits $17.50 or goes below, I would get to buy this company at a bargain price. I don’t see anything in AT&T’s business model that would radically change over the next year and a half – so I am ok with buying the stock cheap.

Please keep in mind that when dealing with options, it is important to not get overleveraged. Just ask the boys at AIG.

In the past, I have recommended writing puts on CNA at $7.50. Those puts were set to expire in January 2010. The stock is now at $24. That is a major win. I see a similar win for the AT&T puts.

Full disclosure – Just wrote these puts on 8/26/09.

Comments

[optionsgirl:]

Very good strategy.

Aug 27 12:29 PM

[PriceVolume...:]

Dan, thank you for you article. It appears to me that selling came in to this stock around 26 on July 23, 2009. The "smart money" then ran the stops on short players on August 3. I would expect this stock to fall back to the 23 level over the next few weeks. Puts would be better priced at that time.

Aug 27 04:52 PM

[Paul Zimbardo:]

I have to problems with this strategy:

First of all, your return is rather low. For each contract you tie up $1,750 in cash to seek a return of $90 (before commissions and fees). This is a return of just over five percent for ~18 months. Not too great given the risks I will mention below.

Secondly, anytime that you lockup a position for such a tremendous amount of time, you face great risks. Just look at what happened in the last year. A fall of 30% is not that unrealistic. If T fell so dramatically, it is likely that the dividend would be cut as well. While you may be happy to own AT&T today at $17.50 (who wouldn't?), you could find yourself waking up in January 2011 owning an AT&T without the exclusive rights to the iPhone, facing Verizon with the iPhone, increased regulatory pressures, a stronger Google model pushing wifi phones, and who knows what else.

When factoring in these risks, I would demand a much greater premium than below five percent annualized.

Aug 28 01:26 PM

[mountain goat:]

I agree with Paul Zimbardo. My broker demands I tie up enough $ to fund the T purchase in their next to nada interest account. Therefore, the $90 I receive is less than what I'd get by putting the money in a Short Term Bond Fund over the 17 months. I could just flag my account for a drop in T's price to $17.50 and liquidate the needed cash to buy from the bond fund.

While the Sht term bond fund could drop in value, partially offsetting my coup on T, it still offers me these advantages over selling the $17.50put: 1) I don't have to BTC the put (probably at a loss) to use my $ for other opportunities over the 17 months. 2) I might chg my mind on T should it strike $17.50 (see a better bargain or ?).

This strategy seems to offer opportunity risk (it ties your $ up), but no real reward, unless your broker lets you sell the put without covering it with $, or lets you cover it with assets in a bond fund.

Aug 29 06:22 PM