Go Long on This Stock While Wall Street Fears It

This week has not been short on market-moving headlines. But this was especially true for the telcos. On Wednesday, T-Mobile US Inc (NASDAQ:TMUS) did it again with yet another new twist on incentives.

AT&T Inc. (NYSE:T), Sprint Corp (NYSE:S) and Verizon Communications Inc. (NYSE:VZ) have been stuck in a cut-throat price war that TMUS is leading. Wall Street hasn’t been too happy about that and their stocks are down more than 10%. Ironically, TMUS stock is up 25% in 12 months.

TMUS has been the consumer’s champion.

They keep upping the ante on a free giveaway to gain market share.

While this makes me want to give them a high five from a client perspective, it makes me worry about the company’s long term margins.

On Wednesday, the company announced that they would give away free Netflix, Inc. (NASDAQ:NFLX) memberships.

Investors sold the sector down on the news. This could get expensive for telcos.

Traders tend to overshoot more often than not. So when stocks are falling they tend to fall too far before stabilizing. Conversely, when they rally they tend to overreach. Usually, there is a happy medium depending on the parameters. In this case, I think that traders are punishing AT&T stock too much and therein lies my opportunity for profit.

No, I don’t want to buy T stock and hope it rallies. I don’t trust these levels to be the bottom in this downturn. I prefer tipping the odds in my favor and that’s why I use options. There I can build a buffer so I can leave a little room for error.

Fundamentally, AT&T is not expensive. It has a trailing PE of 18 and a Price-to-book under 2. So from a valuation perspective, it’s not likely going to be a big mistake owning T stock at a discount from here. So I am willing to take a risk on that factor and this point is critical to my set up.

I also have to account for the Amazon.com Inc (NASDAQ:AMZN) factor. There are still rumors that they will enter the arena and we all know what happens to stocks when that happens. Until then, I can trade the current price action in T.

Technically, it’s never ideal to try and catch a falling knife. T stock had a flash of brilliance when it spiked 10% on earnings. Alas, it has since given most of it back. There is a chance that the bears will continue to overwhelm the bulls for now. So more downside is possible but that is okay given my style of trading.

To win, I merely need to choose support levels that are likely to hold through 2017 and I always leave plenty of room for error.

The Bet: Sell T stock Jan 2018 $32 put and collect 50 cents to open. Here I have an 85% theoretical odds that price will stay above my strike, so I can retain maximum gains. Otherwise, I will own the shares and accrue losses below $31.50.

For those who want to mitigate the risk that comes with selling naked puts, they can sell spreads instead. There the maximum loss is contained by the width of the spread.

The Alternate Bet: Sell T stock Jan $32/$31 credit put spread where I have about the same odds of success and still yield 15% on risk.

Since there are no guarantees when investing in the stock markets, I never bet more than I am willing to lose.

— Nicolas Chahine

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Source: Investor Place