AT&T: An Attractive Options Strategy For The Coming 10 Months

Introduction

AT&T is a well-known dividend aristocrat that managed to grow its cash distributions for over 30 consecutive years. Aside from having generated these dividends, the stock wasn't capable of beating the S&P-500 over the past decade. Also, the 3-year and 5-year trailing returns are anything but exciting.

(Source: Morningstar)


This, however, does not mean that one cannot make significant profits by utilizing AT&T as underlying.


That's why we have to implement option setups to tweak the risk/reward profile significantly in order to throw the odds dramatically in our favor. The main goal of this article is to show you how you can easily double your dividend return while enhancing your return potential if shares go down moderately or increase slightly. We want to set up a trade for the next 10 months with a clear risk/return advantage between $25.5 and $34.5.


(Source: Pro Realtime)


Trade Setup: Base Case Scenario

Let's take a look at the components of the setup I'd like to propose to you:

* Buying 100 shares of AT&T at $28.46

* Selling 1 out-of-the-money covered call with $32 strike price, expiring on January 15th, 2021 (this is when we evaluate the outcome of the strategy)

* Buying and selling straddles with different expiration dates

* 4 dividend payments of $0.52 each, $2.08 in total


NOTE: If the cell representing the net investment is green-colored, then we have a net debit (investment); if it's red-colored, then we receive a net credit.

(Source: Option Generator)


Looking at the returns by using option pricing modeling to determine the value of the longer-term options (20% implied volatility) we get the following picture:

(Source: Option Generator)


As you can notice from the graph above, the annualized returns of this trade setup are superior between $25 and $34. If AT&T trades between $30 and $32 in January of next year, you'll have maxed out your profit potential with an annualized return of 31-33%, noticeably higher than that of the buy and hold investor.


As for the actual P&Ls, I've inserted the following bar chart.

(Source: Option Generator)

(Source: Option Generator)


As one can determine from the following graph, the risk of this strategy is to the downside if we drop below $25. Additionally, we would miss out on additional capital gains if shares trade well above $34.5. For this to happen, the ultimate question we should ask ourselves: is this realistic and/or are we satisfied with a 25% annualized gain versus 26+% for the buy and hold investor ?

(Source: Option Generator)


Trade Setup: Defensive Scenario

The main advantage of options: you can craft them based on your personal risk tolerance and view on the stock (market).


Let's take a look at the components of the defensive setup I'd like to propose to you:

* Buying 100 shares of AT&T at $28.46

* Selling 1 in-of-the-money covered call with $28 strike price, expiring on January 15th, 2021 (this is when we evaluate the outcome of the strategy)

* Buying and selling a call with different expiration dates but same strike price, namely $30

* 4 dividend payments of $0.52 each, $2.08 in total


NOTE: If the cell representing the net investment is green-colored, then we have a net debit (investment); if it's red-colored, then we receive a net credit

(Source: Option Generator)


The purpose of this strategy? In return for capping the upside at $33, we're lowering our breakeven level to $24 (from $26), thereby increasing the chances of a profitable trade. We can still produce a nice annualized return of 30% (based on a $2,633 investment ($2,846 - $213 options credit), though, that figure is slightly less than the 31%-33% we eyed previously. Whether you choose the first setup or this one depends on your personal risk tolerance. But my message to everybody out there: utilize options to create a wider profit zone without missing out on attractive returns.

(Source: Option Generator)

(Source: Option Generator)

(Source: Option Generator)

(Source: Option Generator)

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