Now’s the time to buy calls in AT&T (NYSE: T). That’s according to top options traders.
The stock currently has a dividend yield of 6.39%, more than three-times the current yield of the 10-year Treasury of 2.186%, which may look incredibly attractive to dividend-seeking investors right now.
But according to Mike Khouw, co-founder and chief strategist of Optimize Adivsors, if you look at the stock closely, AT&T looks like a better setup for an options trade.
“You’ve got a tremendous amount of debt on this balance sheet. They’re obviously dealing with the Time Warner integration,” Khouw said. “Usually, when you’re looking at heavily indebted businesses, the thing you’re concerned about is if they also have significant negative cash flow.”
AT&T might be the most heavily indebted company in the world, but it also boasts significant free cash flow that helps offset its leverage, according to Khouw.
And according to Carter Worth, chief market technician at Cornerstone Macro, T’s chart looks like it may be bottoming, which could portend a sustained move higher. Worth says the stock is “an old-line loser that is coming to life.”
But even with its strong cash flow, its large debt load could make the stock more volatile, which is part of the reason investors might want to consider buying call options on AT&T rather than buying the stock.
“Let’s say… you really don’t want to reach and buy the stock despite that high dividend because you are concerned about that downside risk,” Khouw said. “That high dividend tends to make those calls cheap. We actually see that.”
“The July $32 calls, when I was looking at that earlier [last Friday], were trading for about 95 cents, and let’s consider that those were already about 30 cents in the money,” Khouw continued. “That’s really 65 cents of extrinsic premium to make a bullish bet in AT&T because of that high dividend in case the price should start moving up. So, I think there’s actually a pretty inexpensive way to bet on that positive price action without taking a lot of downside risk by just simply going out and buying calls here.”
Dan Nathan, co-founder and editor of RiskReversal.com, agreed with Khouw’s take on the stock.
“You’re not risking a whole heck of a lot – a few percent for about a month and a half, close to two months. It’s already in the money here,” Nathan said. “The purchase of Time Warner is really setting up for this all to come together, and at some point, it’s going to make a lot of sense to start thinking about what this company looks like when they have 5G, they have the content.”
For Nathan, the combination of the high yield, the bottoming pattern in AT&T’s chart, and investors’ flee to safety as trade tensions escalate all make him more bullish on this trade.
“I think it makes sense,” Nathan said. “I think at some point towards the latter half of this year you’re going to see some investors start thinking about what this company looks like in 2020, ’21, the way we saw Disney (NYSE: DIS) just explode once they were able to articulate putting all those pieces together and what their future looks like.”
AT&T is up 11.63% so far this year, and is up 3.48% for the month. Analysts have a consensus Buy rating on the stock and their average price target for T is $36.39, indicating possible upside of 14.23% over the next twelve months.