I love T-Mobile US Inc (NASDAQ:TMUS) for what it’s doing to us cell phone consumers. Their heavy promotions are pushing our cell bills lower. This is at the expense of the Telco companies’ pocketbooks. Heavy promotions put incredible strain on an already thin-margin sector. Having only a few providers I would expect that they’d enjoy fattier bottom lines, but not so.
It doesn’t help that the smartphones that we are buying are basically hand-held supercomputers, which makes them expensive. So someone has to pay for this luxury and it hasn’t been the consumer.
Regardless of who started the price war, the telco wild child TMUS took it to new levels.
Click to Enlarge Given the flashy nature of the stock and its CEO, it’s no surprise that TMUS stock is volatile, up nearly 40% in 12 months. Compare this with AT&T Inc. (NYSE:T) and Verizon Communications Inc. (NYSE:VZ) which are down 15% and 22% respectively. So obviously, telco stock investors are not looking for bargains, since TMUS carries a price-to-earnings ratio that is twice the value of the other two.
Recently TMUS fell hard to cap a 30-day 12% correction and I dared to catch the falling knife. The trade delivered 50% of its potential profits quickly. So now I am looking to reset into earnings.
Key to my thesis is my willingness to own T-Mobile stock if it falls another 15% in the next few months. The idea is to find support levels that should be safe for the near term. Then to generate income, I would sell risk against them and let time do the rest. I can do this to either short the stock or go long it. In this uber-bullish equity market, I find myself not wanting to bet bearish.
So today I will set a bullish TMUS trade but without spending a penny out of pocket. My risk will lie in my intentions to own the shares if I pick the wrong levels.
TMUS Stock Trade
The Trade: Sell the TMUS Jan 2018 $50 naked put and collect 90 cents per contract to open. Here I have a 90% theoretical chance of keeping the entire premium as maximum gains. But if the price falls below it, then I must own the shares and accrue losses below $49.10.
Selling naked puts does require a lot of margin to secure it. I can mitigate the risk by selling a credit put spread instead. I do this by buying the same number of puts but lower than the ones I sell. This would then cap my maximum risk even if TMUS falls to zero.
The Alternate Trade: Sell Jan 2018 TMUS $50/$47 credit put spread for 12 cents, where I have the same chance of success but with less money on the line. Yet I can still deliver 12% in yield. Compare this with risking $61 to buy the shares at face value and without any room for error expect a 12% rally.
In either of these trades I don’t need a rally to profit. In fact TMUS can fall, but as long as it stays above my strike price, I secure maximum gains. The company reports this week and premiums are higher than normal for it. But with an 18% price buffer, I am fairly confident that I can manage my risk should it go against me in the next few months.
The Twist (Optional): I could allocate some funds to buy a debit call spread so I can also participate in upside moves. For this I would use the earnings as the catalyst on an upside surprise. Buy TMUS Aug $65/$67.50 debit call spread for 40 cents. If the price rallies through my spread, I could gain $2.
Trading options is risky business, so I never bet more than I am willing to lose.
Learn how to generate income from options here. 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.
