Option Trades on AT&T (T) for Bulls and Bears

AT&T phone Deutsche Bank upgraded AT&T T Monday morning to a “buy” rating from “hold” and lifted its 12-month price target by $1 to $31, essentially calling for about 20% of upside over the next year. The firm argued that Ma Bell should be able to sustain double-digit core earnings growth into next year. Potential near-term catalysts for continued growth include a buyback and a dividend increase. Additionally, the firm thinks concerns about the potential loss of the iPhone exclusivity contract may be overblown (or already priced into the shares).

Technically speaking, T shares have been range-bound for the past year or so, with little movement below 23 or above 26. Last Thursday, the stock gapped higher, however, thanks to a positive earnings surprise. Upward momentum continued through Friday and Monday, and the shares have now moved back above their 200-day simple moving average for the first time since April.

For investors interested in adding options to their portfolio, we’ve outlined two strategies below – one for those who agree with Deutsche Bank’s positive outlook and one for AT&T bears. These strategies are examples and do not constitute buy/sell/hold recommendations. Prices are given as of Monday late afternoon, when T was trading at $25.95, up 41 cents.

For more information on option strategies, check out the Two Traders, One Strategy webinar series every Tuesday after the close. This afternoon’s webinar is about the collar strategy, which many investors may opt to use during earnings season.

Moderately Bullish Option Strategy: Buy-Write

Think AT&T may have a little more upside (or at least not move lower)? An October-series buy-write could be a good alternative to simply buying the stock outright. This strategy is also known as a covered call, generally when the calls are bought after the stock (the trades occur simultaneously in a buy-write).

An investor could buy 100 shares of T for $25.95 and simultaneously sell the October 26 call for 75 cents. At expiration, if T has inched above the 26 strike, the investor will very likely be assigned and can fulfill his obligation to deliver the shares at 26 with the shares he already holds. At this point, he simply keeps the credit collected (plus the upside in the stock), making the maximum potential profit 80 cents. Because he owns the stock, he will also collect the $0.42 dividend payout, expected on the first business day of August.

The maximum loss, if T were to fall all the way to zero by October expiration (not likely), is $25.20, which is the stock purchase price minus the premium collected. Breakeven is also $25.20. Of course, there is also the so-called “opportunity loss” that comes with this strategy, as the investor will surrender all gains in the stock above the 26 strike.

AT&T buy-write strategy

Bearish Option Strategy: Bear Put Spread

Investors who are beared up on Ma Bell could consider a bear put spread strategy, buying the January 2011 27/22.50 put spread (buying the 27 put, selling the 22.50 put). This spread is currently priced at a net debit of $1.85, which is also the most the investor can lose if T is trading above 27 when these options expire.

The most this investor can gain (excluding commissions) is $2.65 per spread, which is the difference in strike prices minus the premium paid. Gains peak at expiration if T is trading south of the $22.50 strike. Breakeven on this trade is $25.15 at expiration. If T is trading anywhere below this level when the options expire in about 178 days, the spread will be profitable.

AT&T (T) bear put spread