Friday, October 28, 2016

Recent Option Transaction

option strategy, put option, write puts, dividend growth investing
AT&T (T) Jan 20, 2017 $36 Strike Put Option
As part of running this blog that chronicles my journey to financial independence I like to be open and honest with all of my transactions.  Typically that revolves around buying shares of high quality companies that I deem to be at fair value or less.  And occasionally there's a sale of a company like when I closed one of my positions earlier this month.  Being open about the moves I make allows for better discussion with all of you and helps spread ideas around.  If it creates my own "investment journal" to detail why I made the move and my expectations, well that's even better.  

Well last week had a bunch of news regarding AT&T (T) that I'm trying to work through.  For starters there was the announcement of AT&T buying Time Warner and this past Saturday they announced an increase to the dividend as well.  The last bit of update regarding AT&T has to do with a new put option that I opened last Friday.

The great thing about selling put options is that if done correctly you get the best of both worlds where you can earn a synthetic dividend or you get to purchase shares at a discount.

AT&T is a Dividend Champion with 33 consecutive years of dividend growth.  It's the quintessential "widows and orphans" stock due to it's stability and defensive business.

dividend growth investing, income investing, AT&T, T, telecommunications, financial independence
AT&T (T) Dividend Payment History
A larger, interactive version of the chart can be found here.

What'd I Do?

This past Friday I sold to open 1 put contract on AT&T.

Let's go over the pertinent details and then move on to the various ways this can play out.

Company: AT&T, Inc. (T)
Date Opened: 10/21/2016
Expiration Date: 1/20/2017
Strike Price: $36.00
Price of Contract: $0.71
Premium Received less Commission/Fees: $63.00
Share Price at Time Contract Sold: ~$38.32

How can this play out?

For those that don't know much about options I'll cover the general gist of a put option.  Essentially I'm selling someone the right to sell me 100 shares of a company at an agreed upon price, the strike price, on or before the contract expiration date.  However, I'm not going to just do that for free so I receive the option premium up front.  Think of the option premium as an insurance premium payment.

If the share price stays above the strike price, $36, then the put option would be out of the money and therefore unexecutable.  So I would just keep the premium and go on the look for other places to invest my capital.  On the $3,600 in cash that the contract represents that's a solid 1.75% return.  On an annualized basis that works out to a 7.21% return.  

Of course the share price could decline and if it drops below $36.00 then I would likely have to purchase the shares for $36.00 per share even though the share price is lower.  That would suck; however, the option premium actually gives me further downside protection.  If I have to purchase the shares my effective purchase price would be $35.37.  So I'd get to purchase the shares at a 9.16% discount to the share price when I sold the contract.

In my book that's a win win.

There's one other scenario that can play out and that's if AT&T's share price makes a big move higher prior to the expiration date.  In that case I would likely buy back my put option to close out the position and lock in the remaining premium.

One of the risks of the options market is that something can happen that can change the investment thesis in the company.  That's exactly what happened with AT&T as investors haven't exactly rejoiced with the announcement of the potential acquisition of Time Warner.  I can't exactly blame them either.  

I understand managements' strategy of getting a content creator in their coffers to create a more vertically aligned business; however, the issue is the timing of the purchase.  This late in the business cycle/bull market with valuations already stretched why then also pay a premium to buy out a company.  Especially when you have to do so by diluting current shareholders with the issuance of shares AND you have to issue an additional $40 B or so in debt.  Considering management had stated their goal after the DirecTV acquisition was to use excess cash to reduce debt this is in stark contrast to their previously stated intentions.

With the acquisition announcement coming while my limit order was on and I wasn't paying attention to the markets I missed a big chunk of premium or downside protection.  In the afternoon on Friday I could have sold the same put option for about 50% more premium or received the same premium by selling the $35 strike put and getting further downside protection.  Such is life though.

My initial goal with this put was to try and close it out early and book in some profits.  With the share price currently down at the mid $36 level that will likely take longer to get the premium down to a reasonable level to lock in some gains considering there's about 3 months left until expiration.  Of course, maybe investors will change their tune a bit and bid shares up higher.  Even if the shares are put to me I'll be happy to own a stable and defensive company that would be offering a yield on cost of 5.54% and my likely strategy would be to turn around and write covered calls on the position.

I've updated my Option Summary page to reflect this change.

Do you incorporate an option strategy with your portfolio by selling covered calls or writing puts?

Please share your thoughts below!

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5 comments:

  1. Thx for sharing the story on this put and take over. It is not something I follow-up closely,so a small update is nice

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    Replies
    1. AT,

      There's lots going on considering that AT&T is normally just a stodgy old company. I wish I didn't have the limit order set for this put option because I could have gotten more downside protection via higher premium or even lowering the strike price. But that's the benefit of selling puts on dividend growth companies that you don't mind owning anyways.

      Thanks for stopping by!

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  2. TWX closed at $87.47 today but the AT&T deal is for like $107 something right?

    Looks like Mr. Market is giving pretty low odds that the deal goes through.

    Not that that helps much with your option contract...actually it's probably worse since it implies that T is likely to waste a bunch of time and money trying to save a doomed deal. Boy that was some very unfortunate timing with the limit order...

    I hope it works out for you.

    ReplyDelete
    Replies
    1. catfishwizard,

      I don't remember what it works out to on a per share basis for TWX.

      I've heard a lot of people thinking the deal won't go through although I'm torn on it. I guess overall I'd like for it to not go through because I think they're paying too much for the TW content, but I think it would fit in with their strategy. I need to double check to make sure there isn't a breakup fee that T has to pay like they did with TMUS.

      It definitely was bad timing but such is the problem with investing in the markets. I think there will be opportunities to write calls if the shares are put to me to help me generate a bit of extra income especially with the deal not expected to close until the end of 2017 if it goes through. Although who knows if/when it'll be stopped.

      Thanks for stopping by!

      Delete
    2. There is $1.5B breakup fee if it just doesn't happen for whatever business reason. But they only have to pay up to $500M in legal fees if the regulators kill it.

      I double checked: deal price is $107.50. Implied odds that it goes through are ~28% although the merger arbitrage business isn't what it used to be: It's possible the market mechanism for that isn't exactly working correctly. But if that's the case you'd want to be buying TWX not T...

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