A few weeks ago when AT&T was hovering above the 52 week low we bought shares along with an options overlay to add potential yield and leverage. Here was the initial trade and the rationale from April 8th:
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.
With the stock up 6% since, the trade is profitable. But today’s Fed announcement is a significant event for AT&T. A hawkish Fed statement could take the air out of some high yielding stocks/sectors like AT&T. Conversely, a dovish statement could send shares even higher which means the 1×2 is at risk of calling away the long too soon.
Right now the long stock has gained about 2.50. The 1×2 overlay has lost about .35 against the gains as short deltas of the position have increase as the stock moved higher. Those short deltas are about -40 with the stock here (against the 100 deltas of long stock, for about +60 total on the position). What that means is hour to hour and day to day a move higher in the stock is still profitable and moves lower lose some of the gains. Additionally, those short deltas increase as the stock goes higher and decrease as the stock goes lower. Ultimately the max gain on the upside is an effective sale of the shares at 36.04. The ideal spot for the stock is still $35 on June expiration.
But June expiration is a long time from now and therefore it makes sense to think about trade management. We debated if we should just ride the shares higher and take off the 1×2 at a slight loss. But that’s effectively adding 40 deltas to the position after the stock is higher by a few dollars. Not ideal.
And although a move lower in the stock eats into overall gains, the 1×2’s -40 deltas is acting as a bit of a hedge against the shares here. So we’re comfortable with the position overall and will leave it as is for now. $35 is our ideal spot and although a move lower on the Fed announcement would initially cost us some profits, the 1×2 actually adds some yeild each day in the form of decay as long as the stock is between 34 or higher. That yield comes in the form of decay (theta) and that decay collected picks up over time into June expiration.