Michael Fowlkes' Analyst Insights
Options and ETF Analyst Writer
July 27, 2015 - Earnings Season Brings Just Enough Volatility to American Tower
American Tower Corporation (AMT) is admittedly a rather boring stock. The company is a real estate investment trust, investing in real estate markets across the globe.
The stock rarely makes any big moves in one direction or the other, and over the last 52 weeks the stock has remained between $90.20 and $106.31, so investors should not expect huge swings from the stock. However, around earnings season, a little extra volatility comes into the stock, and we can use this volatility to our advantage.
Earnings season is always a tense, yet somewhat exciting, time for investors. Analysts set their forecasts for the quarter, and fortunes can be made or lost for investors depending on how close to the consensus a stock reports its quarterly numbers. Not only can past earnings come into play, but so can any comments a company makes regarding the future outlook for the business.
The last time AMT reported earnings was on April 30, and the company missed its earnings forecast of 54 cents per share, with a reported 45 cents. Revenue was better than expected, and up 9.6% year over year.
Following the earnings miss, the stock moved lower, but not too much. The stock fell just 1.1% on the day of the earnings miss, which is a true testament to just how stable the stock is.
While investors will find it difficult to pull huge returns out of the stock, ahead of earnings there is some extra volatility in the stock, which creates a good buying opportunities using options to boost the target return.
Currently, the stock trades at $97.50, has a P/E of 50, and an incredibly low volatility beta of just 0.4. Such a low beta means that the stock will not move nearly as much as the overall market, but we can still find a strategy to boost our target return on an AMT trade using the covered call strategy.
We are going to look at setting up a January 2016 call on AMT using the $97.50 calls. To set up the January $97.50 covered call, you would buy shares in AMT (typically 100 shares, scale as appropriate) and sell the January $97.50 call for a debit of no less than $92.60 per share.
Charts courtesy of www.stockcharts.com
Using this strategy, you successfully establish a holding in AMT with a $92.60 cost basis, which now serves as the break-even point on the trade, and represents a 5.0% discount to the current trading price. With a security such as AMT, which does not make wild swings, a 5.0% discount is a huge advantage, and offers a great opportunity to realize a nice gain even in a stock with low volatility.
As long as AMT is above $97.50 on January 15 when the sold calls expire, our sold calls will be assigned, and the market will exercise its right to buy our shares at $97.50. With a cost basis of just $92.60, that creates a potential 5.3% profit. With the trade open 175 days, the annualized return on the trade would then be 11.0% (for comparison purposes only). This is a much greater profit than could be expected by simply buying a stock that typically trades with such low volatility.
On the other hand, AMT could fall below $97.50 when the option expires, and in this scenario we would be left holding on AMT shares. The bright side is that the shares carry a cost basis well below the current price, and as long as shares don't dip below $92.60, they can still be sold for a profit. The other possible moves would be to sell another call further out in the future to lower the cost basis even more, or hold the shares and wait for an upswing to unload the holding at a higher profit.
Should AMT fall below $92.60 we would be looking at a loss. We could take the loss, sell another call to lower the cost basis and limit the loss, or hold the shares and wait for the market to pull the shares higher.
Even in the worst-case scenario, the outcome is not horrible. You are still able to own AMT shares at a cost basis well below the current market price, and that is why the covered call strategy is more favorable to simply buying shares. This is typically the case, but even more so in less volatile stocks since the potential profit is so much higher versus simply acquiring shares.
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