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Outside The Box: A Disconnected Call in AT&T

Chris Tyler, Optionetics.com
March 29, 2011

Call buying appeared to be a popular preoccupation in AT&T (T) Monday following a raise by analysts at Robert Baird to “Outperform” along with many of its telecom peers including Dow constituent Verizon (VZ). The round of upgrades comes on the heels of last week’s T-Mobile acquisition by AT&T and one which the broker feels will “stabilize the hyper-competitive industry.”

Technically speaking, shares of T look bullish. Monday’s heavy volume upside thrust of 1.77% represents a pattern breakout above “W” mid pivot resistance. The slightly unorthodox double pivot near 28.90 aligned itself nicely with its January 2010 highs.

Further fuel for bulls comes from the idea that shares of T have endured plenty of base-on-base or "base reset" weekly work and could be due for some upside as a result. With an initial breakout attempt back in October turning into weekly base, then T going on to form a subsequent failed breakout in January of this year; bulls could have good reason to consider whether three times will prove to be the charm.

If you think the resolution in share price is to the upside, you're not alone. However, if you’re a fan of the fast money’s favorite play today, a “bid” but far from over-the-top April 29 call which traded more than 11,500 contracts; do realize this particular cheap looking option is slightly more expensive than meets the eye.

In defending the call, which closed at $0.54 per contract with shares at $29.36, the 15% implied volatility isn’t all that expensive when compared to statistical volatility in the mid to high teens. Of course, when dealing with front month options, theta risk could still foil one’s plans to make a nice call on the stock, pardon the pun. The other and slightly more devious detail that may otherwise go unnoticed but should be accounted for is AT&T’s quarterly dividend; which looks to be a double whammy of sorts for call owners.

First, the amount for the contract to double, which is supposed to be about 2.50% by expiration, could become a stiffer 4.00%. The problem is AT&T pays out $0.43 per share each quarter with the next ex-date on April 6. Theoretically, this means if shares were to remain at 29.36 into the ex-date, traders long the 29 call would find themselves and their purchased slightly in-the-money call, quickly out-of-the money with shares at 28.92 and only a week and one-half to expiration remaining. From that ex-dividend share level, it would take our formulated and larger percentage move of 4.00% in order to double in price to $1.08 per contract.

Figure 1: AT&T (T) Daily and Call “Double”

Another potential hazard is AT&T shares have had a way of making its dividend collection machine (for shareholders) a tough one to navigate. Over the past two years and on the ex-date, T shares have fallen much harder than the actual dividend payout in seven out of the last eight cycles. In fact, eyeballing the average downside and bulls would have been better off buying the stock on the ex-date without help from the company but from other shareholders caught dumping stock for whatever reason they saw fit that day.

What’s more, in only three of the eight prior ex-date periods into expiration for the front month contract, would this type of call buyer have found their position closing in-the-money by holding until the sometimes very bitter end. Net, net—despite this analyst’s own optimistic take on the stock and Elliott’s rather tempting W5 TAPP which sports a midpoint of $31.75 on expiration Friday, April 15th—I’d say owning April premium like Monday’s most active; could be rather “taxing” to one’s financial health within a historical context.

Chris Tyler
Senior Options Writer, former Market Maker & fulltime Option Hedge Hog Advocate
Optionetics.com ~ Your Options Education Site