Option Strategies for Trading Verizon Communications (NYSE:VZ)

Verizon Communications Inc. VZ has seen a significant increase in volume in 2011. While part of this is attributable to an overall market increase in trading activity, the impending availability of the iPhone has also sparked interest among investors.

Since the January 11 announcement that Apple's smartphone is coming to the VZ network on February 10, VZ shares have been virtually flat after a mid-month pullback. Wall Street's short-term outlook has been mixed on the stock. While Deutsche Bank recently downgraded the stock from buy to hold, Goldman Sachs added it to its conviction buy list, noting that the carrier's “appeal to investors should improve over the course of the year.”

There are two ways an investor might think of the Verizon/iPhone news. The bulls could think that the VZ/AAPL pairing will markedly increase Verizon's customer base, helping company earnings and the stock price trend higher. The pessimists among us might believe that this news is already built into the shares and could expect a “sell the news” phenomenon as the iPhone hits shelves.

Either way, investors may be looking for alternatives outside of simply buying or selling the shares. We've outlined two option strategies below, one for the bullish and one for the bears. These examples are for educational and demonstrative purposes only and are not buy/sell/hold recommendations.

Prices below were taken ahead of Wednesday's open. VZ shares were trading at $36.27.

Bullish Option Strategy: Buy Write

Verizon pays a relatively high dividend of 48.75 cents each quarter. The next payment is expected around May 1. An investor who wants to benefit from both the dividend payout and the leverage of options could consider a covered call/buy write, which consists of a long stock position plus a short call.

The premium collected for selling the May 37 calls is 97 cents. Add in the quarterly dividend of 48.75 cents per share, and the potential income for this trade is $1.46 through May expiration, assuming traders do not have their shares called away. As with similar short call plays, one caveat is you won't receive the dividend if the short call sellers are assigned (obligated to deliver VZ shares to the call buyer) ahead of the ex-dividend date.

The maximum potential profit at expiration for the covered call (not including the potential dividend payment) is the 73-cent gain in the shares up to $37 plus the 97-cent premium collected, or $1.70 in total. Breakeven is $35.30, or the stock price at the time of purchase less the premium collected.

If the short call is not exercised, there is downside risk all the way to zero because of the long stock (visible in the profit/loss chart* below). This downside is limited to $35.30, however, as it is offset by the credit collected for the short call.

*Investors have access to the profit/loss calculator and other tools through an OptionsHouse virtual trading account. This calculator to illustrate how the profit/loss relationship changes due to movements in the stock price, implied volatility, or other factors.

Bearish Option Strategy: Bear Put Spread

Investors expecting a pullback in Verizon could consider a shorter-term bear put debit spread, such as the March 38/35 spread. The net debit for buying the 38 put and selling the 35 put is $1.57. If VZ is trading below the 35 strike when the options expire, the investor receives the maximum potential profit of $1.43 (the difference in strike prices less the premium paid). The downside breakeven is $36.43; the spread will be profitable at expiration if VZ is trading anywhere below this level.

The maximum loss is the $1.57 premium paid in the event that VZ is trading above 38 when the options expire. Return on risk is therefore 91% through March expiration.

Profit and loss of Verizon Communications (VZ) bear put spread

Photo Credit: Eric Hauser

The above information is provided by OptionsHouse, LLC (“OptionsHouse”) for informational and educational purposes only and is not intended as trading or investment advice or a recommendation that any particular security, transaction, or investment strategy is suitable for any specific person. You are solely responsible for your investment decisions. Commentary and opinions expressed are those of the author/speaker and not necessarily of OptionsHouse. Neither OptionsHouse nor any of its employees, officers, shareholders or affiliated companies guarantee the accuracy of or endorse the views or opinions of guest speakers or commentators. Projections or other information regarding the likelihood of various investment outcomes are hypothetical in nature and are not guarantees of future results. Any examples used that discuss trading profits or losses may not take into account trading commissions or fees.

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