With Sprint Corp (NYSE:S) locked in a price war that was, for the most part, started by T-Mobile US Inc (NASDAQ:TMUS), the consumer is the one who wins. I know this because my own cell phone bill was cut in half compared to less than two years ago. Clearly, the telecoms are all suffering from pricing pressure, but they will eventually figure out how to adjust their income statements accordingly.
In the shorter term, Sprint stock is at an important level that needs to hold. If it loses the $6.15 per share area, which has recently served as support, Sprint could fall another 30 cents, placing S stock at the $5.85 per share.
Although, this also would be another support level, below it, Sprint shares enter a “chutes and ladders” situation. In July, Sprint stock spiked 70 cents too fast from the low $5 per share level. This makes it a vulnerable area for Sprint bulls.
But since there is nothing showing that this is imminent, I can take a speculative stab at generating profits from a mid term long S trade.
The Trade: Sell the S Jan $5.50/$5 credit put spread. This is a bullish trade for which I collect 12 cents to open. If successful, this would represent a 30% potential yield with a 12% buffer from current price. This is the maximum that I could profit. Conversely, my total risk (should S stock fall through both legs of my credit spread) is only 35 cents per share.
This is a textbook example of a calculated risk. I am basically selling a lottery ticket to someone who believes that Sprint Corp will fall to $5 per share or below by mid-January. That is a risk I am willing and able to take.
I can modify this trade depending on my sentiment in the next few weeks. I can add calls if I believe that S is about the breakout. Or conversely, I could add a cheap shorter-term put position if I fear a stock fall on headlines that may or may not be related to Sprint Corp. Markets are trading on fluctuations in the price of crude oil, the U.S. presidential election and the Federal Reserve’s rate hike cycle.
If I were willing to own Sprint stock out right, I could modify the trade to potentially generate a much bigger income. Instead of selling a credit put spreads, I would sell naked puts. I only do this if I am willing and able to own Sprint stock at the level I sell.
Here is an example: Sell the Jan $5.50 put and collect 30 cents per contract. This more than doubles the premium of the sold spread. But as a compromise, I commit to losses all the way to zero below $5.50. Compare this to only 35 cents at risk when selling the spread, even if Sprint stock falls to zero per share.
I fear the reaction to the Federal Reserve the most. Out of the other two named here, the rate hike cycle is the only one with a lasting effect on company P&L’s.
Nicolas Chahine is the managing director of SellSpreads.com. As of this writing, he did not hold a position in any of the aforementioned securities. You can follow him on Twitter at @racernic and stocktwits at @racernic.
