New Trade – $T: Rethink Possible Yield

by Dan April 8, 2015 12:42 pm • Commentary

It’s probably not news to you, but at this point there are a few large external factors (that have been volatile of late) that are heavily influencing U.S. corporate earnings: commodity prices and their effect on input costs; interest rates (and investors expectations) and the strength of the dollar. While the volatility in the aforementioned have been extreme, we have in the last few months started to see this movement seep into specific equity sectors like Consumer Staples, Energy, Tech and Utilities.  

The strength of the dollar has obviously had an adverse affect on large U.S. multi-nationals’ earnings and sales from abroad, while the decline in commodity prices has been beneficial to many of the same sectors, as  a major input cost has been nearly halved in the last year.  And then there are interest rates that given the pace of the economic recovery seem less and less likely to ever increase.  Put it all together and it is not obvious that lower input costs and low rates are enough to offset the strength of the dollar for these multi-nationals.

But there are a few large U.S. companies that sit in an interesting spot amongst all those factors. One name I want to focus on is AT&T (T), which gets all of its sales from the U.S. (so no dollar impact), benefits from low rates to continue to fund buybacks & acquisitions and its consumers benefit from lower oil prices from paying less at the pump.

The stock has performed very poorly of late, down 2.8% in 2015, and down 13% from the 52 week highs made last July.  The price decline has pushed the dividend yield on AT&T to 5.75%, which is pretty meaty. Oh, and the chart is a train-wreck, with a series of lower lows and lower highs and once again approaching the 52 week lows.  But here is the thing, the stock is also approaching massive long term support at $32, if it can hold these levels, the stock could be poised to move back towards the mid $30s on the slightest bit of good fundamental news and/or investors continued search for yield:

[caption id="attachment_52579" align="aligncenter" width="600"]T  5yr chart from Bloomberg T 5yr chart from Bloomberg[/caption]

AT&T will pay its next quarterly dividend of 47 cents in early July, which gives long holders a buffer nearly to the key support level (stock is $32.65 as I write).  Here is a situation where I would be more inclined to buy the stock, and use a hard stop of $32 than buying calls or call spreads as the dividend yield is the main reason for even looking at the trade to begin with. But I do want to use options in another way:

TRADE – Buy 100 shares of T ($32.65) vs. buying the June 34/35 1×2 call spread for .04 credit

– Buy 100 shares of T for 32.65

– Buy 1 June 34 call for .46

– Sell 2 June 35 calls at .25

Rationale – The option portion of this trade does nothing against the stock if it goes lower or only slightly higher by June expiration (you collect .04). However, above $34 in the stock it adds yield of up to 1.04. Above $35 you sell your shares but at an effective price of $36.04. The potential additional yield is more than twice the dividend. Ideally you’d like to see this stock near $35 on June expiration, have the added yield from the options, gains in the stock, and be set-up to receive the dividend in the stock in July.