AT&T’s Unusually Active Options a Much Better Bet Than the Stock Itself

AT&T’s (T) options volume was off the charts on Thursday with a volume of 511,324, 2.7x its 30-day average. The wireless carrier’s stock gained 2% on the day. 

The cause of the excitement was an upgrade from J.P. Morgan. Analyst Richard Choe upped his rating to Overweight from Neutral with a $3 increase in its target price to $21, 18% higher than where it’s currently trading. 

AT&T reported mediocre earnings on Jan. 24. While it's interesting that the analyst waited so long to upgrade T stock, an upgrade is an upgrade. According to Barchart.com data, the 19 analysts covering its stock rate it a Moderate Buy (4.05 out of 5) with a target price of $21.61, almost identical to Choe’s.

I've been an AT&T bear for many years. 

Despite my feelings about the company’s debt, I recommended the July 19 $19 call in January. With an ask price of $0.42, I figured 190 days to expiration was plenty of time to double your money on the call. Its stock closed Jan. 11 at $16.23. It’s up nearly 10% in the three weeks since. As I write this Friday morning, the ask is $0.56, up 33% over the same period. With 168 days to expiration, the odds are good the option will double. 

So, returning to yesterday’s unusually active options, the March 15 $19 call accounted for 63% of AT&T’s overall volume with a Vol/OI ratio of 210.44. It was the highest ratio of any option expiring next Friday or later.  

I wouldn’t buy AT&T stock if you paid me, but the options remain an excellent way to generate income with minimal risk. Here’s why.

Have an excellent weekend.

The Risk/Reward Proposition Is in Your Favor

The $19 call expiring on March 15 had a volume of 323,242. Of that, 154,543 was for one trade at 11:41 yesterday morning. That’s a big bet. 

The trade was at $0.18, a down payment of less than 1%. I’ve had larger Starbucks orders. With a delta of $0.24875, you can double your money on the $18 bet if AT&T’s share price increases by 73 cents over the next six weeks. 

Forget the company’s fundamentals and consider the probability of its shares increasing by 4%. It’s pretty good. T stock has gained 13% over the past three months and 24% over the past six. In a little over a month in 2024, they’re up more than 6%. 

In the worst-case scenario, you’re out $18 per contract. 

With analysts' target price over the next 12 months at $21, it might be a good income play to keep rolling over mid-term expirations around the 42 to 56-day timeframe. They won’t cost you a lot, but if the analysts are correct, you should make out very well with minimal risk.

Why Do I Dislike AT&T Stock?

For me, it all revolves around its debt situation.

“I’ve been bearish about AT&T since it saddled itself with massive debt by announcing it would acquire Time Warner in October 2016. The wireless carrier completed the transaction in June 2018, almost two years later,” I wrote in January. 

“Less than four years later, AT&T spun off its Warner Media subsidiary, which merged with Discovery Communications in April 2022, to form Warner Bros. Discovery.”

In fairness to AT&T, I also said there were probably more gains ahead in 2024 because of the debt repayment job it has done over the past two years. To its credit, it’s managed to carve that much lower with healthy free cash flow generation. 

As it showed in its Q4 2023 results, its free cash flow in 2023 was $16.8 billion, 19% higher than $14.1 billion in 2022. In 2024, the company’s calling for $17.5 billion in free cash flow at the midpoint of its guidance, 4% higher than in 2023. Realistically, they’ll probably do better than guidance. Let’s assume $19 billion.

That leaves plenty to keep paying the $1.11 a share in annual dividend payments. In 2023, it paid out $8.1 billion for dividends, leaving it with nearly $11 billion to reinvest in its business, pay down more debt, and possibly buy back its stock.

These are all good things. So why the negativity, you might ask? Let me tell you. 

Everything Has to Go Like Clockwork

As the Q4 2023 press release stated, it expects to get its net debt-to-adjusted EBITDA down to 2.5x by June 2025. In 2023, its net debt was $128.9 billion, and its adjusted EBITDA was $43.4 billion, for a net debt-to-adjusted EBITDA ratio of 3.0.  

In 2024, it expects adjusted EBITDA to grow 3% over 2023 to $44.7 billion. Let’s assume it reduces its net debt by $5 billion this year to $123.9 billion. That’s a net debt-to-adjusted EBITDA ratio of 2.8, 30 basis points away from its target.

Furthermore, using S&P Global Market Intelligence data, AT&T’s net debt was $148.2 billion as of Dec. 31. It rightfully includes $17.6 billion in operating lease liabilities, while its EBITDA number is $41.8 billion for a 2023 net debt-to-adjusted EBITDA ratio of 3.5, 50 basis points higher than the company’s figure in its Q4 2023 financials.

Reaching its target is possible, but everything will have to go just right. When has that happened for AT&T in the last decade?

But I do like the options.

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