AT&T recently earned a designation as a top value stock by Goldman Sachs. While the stock has been an underperformer in recent years, the yield at 5.8% makes it attractive as an income play. A covered call option strategy is a way to boost the income from T stock.
Earnings Coming On T Stock
AT&T stock is due to report earnings before the opening bell on Wednesday and analysts are specifically watching the 2023 free-cash-flow outlook. The looming earnings report may inflate option premiums compared to normal. That makes a covered call strategy on T stock even more advantageous for investors.
Early in December, implied volatility for T stock was around 18%, but is currently sitting at 27%, despite the general market volatility dropping during that time.
The Covered Call Strategy
When selling a covered call, the investor receives a premium and is then obligated to sell their shares at the strike price if called upon to do so.
One call option contract represents 100 shares, so investors can sell multiple call options if they have a particularly large stock holding.
Over time, covered calls can increase returns while also decreasing the volatility of a portfolio.
On T stock, a February call option with a 19.50 strike traded yesterday around 45 cents. That means every contract brings in $45 of premium.
AT&T stock paid $1.11 in dividends in the last 12 months. Generating another 45 cents in around three weeks is quite attractive. That increases the annualized yield by 35%.
Reducing Cost Basis And Volatility
The 45 cents in premium is roughly 2.3% of the stock price for T stock. That gives an investor a reduced cost basis and small buffer on the stock. In other words, T stock could trade 2.3% lower between now and Feb. 17, and the covered call trade still breaks even.
The break-even price is calculated by taking the stock purchase price and subtracting the option premium received.
The total capital at risk in the trade would be $1,867, and in the unlikely event that T stock went to zero, that's how much the trade would lose.
Covered calls are a fantastic way to generate income from a stock holding while also providing some downside protection. You are giving up something though. If T stock trades above 19.50 at expiration you won't participate in all the upside. Your shares will be called away and your profit capped at 19.50.
The Numbers On T Stock
Investors need to weigh the pros and cons of the stock before initiating a bullish trade like a covered call.
The options market is anticipating AT&T stock could move around 4.9% following the earnings release.
According to the IBD Stock Checkup, T stock is ranked No. 4 in its group and has a low Composite Rating of 38, an EPS Rating of 50 and a Relative Strength Rating of 70.
Please remember that options are risky, and investors can lose 100% of their investment.
This article is for education purposes only and not a trade recommendation. Remember to always do your own due diligence and consult your financial advisor before making any investment decisions.
Gavin McMaster has a Masters in Applied Finance and Investment. He specializes in income trading using options, is very conservative in his style and believes patience in waiting for the best setups is the key to successful trading. Follow him on Twitter at @OptiontradinIQ
