AT&T Covered Calls? We Prefer These 5 Big Dividends Instead

For illustration, the following table shows the recent call premiums you’d receive for selling AT&T covered calls (assuming you already own AT&T stock) that expire on Sept 16, 2016. 

The table also shows the number of standard deviations away from AT&T’s current price the call option strike prices are to help you gauge the likelihood that the options will actually get executed. The standard deviations are calculated over the same number of days as there are to the call expiration date. And remember, there’s about a 65% chance the price will be within one standard deviation, and a 95% chance it’ll be within two standard deviations (assuming a normal distribution). And if the calls get executed, your profit will be the price appreciation (strike price minus current price) plus the premium for selling the call in the first place (for this example, we’re ignoring the $0.48 dividend to be paid on 8/1, but you get to keep that too). 

The premium you receive for selling AT&T calls is not horrible (but we’ll show you better options later in this report), but the real risk is the opportunity cost. AT&T is expensive, and we believe the stock has relatively less upside (and potentially some risk of a pull-back) for the reasons we’ve described earlier (i.e. growing payout ratio, and unappealing DCF valuation). It’s not at all uncommon for stocks (such as AT&T) and categories of stocks (such as big dividend telecoms) to experience significant underperformance after periods of very strong performance (remember AT&T and telecoms are up much more than the rest of the market so far this year). We’re certainly not saying AT&T can’t go much higher (it can), we’re just saying we believe there are better risk-adjusted opportunities for income-focused investors. Remember, you can pick up a few extra percentage points per year by selling covered calls, but how much good does that do you if the stock you’re holding to write the calls underperforms the rest of the market by 10 to 15%?  For your consideration, we highlighted (below) five big dividend options we consider more attractive than an AT&T covered call strategy.

Five Big Dividend Options We Like More Than AT&T

Gilead (GILD): We like Gilead covered calls more than AT&T covered calls for a variety of reasons (Gilead is a large-cap biopharmaceuticals company). For starters, Gilead covered calls offer a more attractive absolute, price-adjusted, and risk-adjusted call premium than AT&T as shown in the following table.

Specifically, you’ll notice that the strike price of both call options is 0.8 standard deviations above the current price (indicating a similar amount of risk, in this sense), but Gilead calls offer a bigger premium for the risk (i.e. you get paid more). Plus, we believe Gilead’s valuation is more attractive than AT&T’s. For example, the following chart shows Gilead’s historical price-to-earnings ratio sits near historical lows.

Gilead is currently very profitable, but the market expects profits to shrink as competition creeps in with regards to Gilead’s blockbuster HIV and Hepatitis drugs. For example, Gilead missed earnings expectations in Q1 of this year, and profits shrank in Q2, especially versus the second quarter of the previous year. However, we believe the narrative has become too negative considering Gilead’s ability defend its big revenues and profit margins, its track record of generating new growth, its strong cash flows, and its discounted price. Plus it offers an attractive dividend yield (2.3%), and the dividend payment was already increased this year. We believe owning Gilead and using it to write covered calls is a more attractive investment opportunity than AT&T for long-term income-focused investors.

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Disclosure: None.

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