Yield or Stop Sign? – $VZ

by Dan June 22, 2016 1:35 pm • Commentary• Trade Ideas

Shares of Verizon (VZ) are up 10% in the last month, now approaching 2016 highs:

VZ ytd from Bloomberg
VZ ytd from Bloomberg

And threatening a long term breakout:

VZ 5yr chart from Bloomberg
VZ 5yr chart from Bloomberg

The stock’s 4.17% dividend yield is one of the big drivers for the out-performance over the last month, a period that had seen the 10 year treasury yield drop from 1.85% to 1.52% before this week’s rebound to 1.7%.

On June 10th, when VZ was a few dollars lower, we detailed a super yield position versus long stock. The stock is now towards the upper end of the range we highlighted. So chasing the stock here is probably not a good bet. Especially in front of Q2 results in late July that will likely show a continuation of weak pricing trends due to promotions. The quarter will also include any disruption from their strike (that was resolved last month).

Short dated options prices are cheap, with 30 day at the money implied volatility just below 16%:

From Bloomberg
From Bloomberg

U.S. Treasuries caught a bid in the last couple of weeks as expectations for a YES vote to Brexit increased. With fear somewhat abating for tomorrow’s referendum (betting markets have Remain as odds on favorite despite polls still too close to call) Treasuries have come off, yields have risen, but yield proxies like VZ have held pat.  It’s my sense that if the June non farm payrolls rebound sharply, investors may start to once again price in a greater potential for for the Fed to raise rates at their July 27th FOMC meeting (Fed Fund Futures currently pricing a 6% chance).  This could cause a stock like VZ to pull back.

If you are of the belief that VZ gets rejected at the prior highs, that Q2 earnings will disappoint on July 26th and that expectations for a rate increase on July 27th could increase, then a defined risk short in VZ makes a ton of sense given the relative cheapness of options prices, unusually positive sentiment and the technical set-up.

So what’s the Trade?   

*VZ (54.20) Buy the July/Aug 52.5 put calendar for .50
  • Sell 1 July 52.5 put at .55
  • Buy 1 August 52.5 put for 1.05

Rationale – This is a mildly bearish trade up to July expiration as it targets a slight pullback to 52.5. After July expiration it can either be closed or rolled to maintain the bearish positioning in August.

We’ll be exploring more trades with similar themes if it looks like the UK remains, removing one main barrier (the other being the jobs number in July) from the Fed being able to pursue a rate hike this Summer.