Thursday, February 3, 2011

Establish Sprint Nextel Corp. Covered Calls

A new covered calls position was established today in the Covered Calls Advisor Portfolio(CCAP) with the purchase of Sprint Nextel Corp.(S) covered calls as follows:

Established Sprint Nextel Corp.(S) Covered Calls for Feb2011:
02/03/2011 Bought 1500 S @ $4.32
02/03/2011 Sold 15 S Feb2011 $4.50 Calls @ $.12

This investment in Sprint is made primarily based on the current bullish analysis by both Credit Suisse and Greenlight Capital(David Einhorn). Credit Suisse's most recent commentary on Sprint's compelling valuation: "Sprint is trading at a FCF yield of 18% compared to peers at 10-12%. We believe this discount is untenable as Sprint starts to grow revenues in the 4th Qtr. We value the core business at $6 (13% FCF yield). In addition, we see $4 per share in incremental value from their Network Vision project. Sprint remains the most compelling stock in telecom; reiterate Overweight and $8 Target Price."

In Greenlight Capital's (David Einhorn) 4th Qtr 2010 letter, their comments on their new Sprint position includes: "Sprint’s disastrous Nextel acquisition in 2005 put the company on a painful downward spiral. We think S is now showing the early signs of a promising turnaround. Dan Hesse joined S in 2005 and became CEO in 2007. He has focused on customer service and improving the handset lineup, which have both improved considerably. This has driven subscriber additions and reduced customer churn. We believe S has a significant margin expansion opportunity as it consolidates two networks. Lastly, we think S’ uniquely large spectrum position through its direct holdings and via its interest in Clearwire is a valuable competitive advantage in an industry where spectrum is becoming a scarce resource. We value S at a discounted cash flow value of over $10 per share if management delivers on its targeted savings from network modernization."

Some possible overall performance results(including commissions) for the Sprint transactions would be as follows:
Stock Purchase Cost: $6,488.95
= ($4.32*1500+$8.95 commission)

Net Profit:
(a) Options Income: +$159.80
= (1500*$.12 - $20.20 commissions)
(b) Dividend Income: +$0.00
(c) Capital Appreciation (If Sprint price unchanged at $4.32):
-$8.95 = ($4.32-$4.32)*1500 - $8.95 commissions
(c) Capital Appreciation (If assigned at $4.50): +$261.05
= ($4.50-$4.32)*1500 - $8.95 commissions

Total Net Profit(If stock price unchanged at $4.32): +$150.85
= (+$159.80 +$0.00 -$8.95)
Total Net Profit(If stock assigned at $4.50): +$420.85
= (+$159.80 +$0.00 +$261.05)

Absolute Return if Unchanged at $4.32: +2.3%
= +$150.85/$6,488.95
Annualized Return If Unchanged (ARIU): +53.0%
= (+$150.85/$6,488.95)*(365/16 days)

Absolute Return if Assigned at $4.50: +6.5%
= +$420.85/$6,488.95
Annualized Return If Assigned (ARIA): +148.0%
= (+$420.85/$6,488.95)*(365/16 days)

The downside breakeven price at expiration is at $4.20 ($4.32 - $.12).
Using the Black-Scholes Options Pricing Model in the Schwab Hypothetical Options Pricing calculator, the resulting probability of making a profit (if held until Feb2011 options expiration) for this Sprint Nextel Corp.(S) covered calls position is 61.9%. This compares with a probability of profit of 52.3% for a buy-and-hold of Sprint Nextel Corp.(S) stock over the same time period.

4 comments:

  1. Any other specifics about this stock position? Does earnings next week play a factor(as in higher vol premium for the option)?

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  2. Good point. The uncertainty related to the earnings next week does substantially inflate the implied volatility.

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  3. Congratulations! Sprint closed OTM by a penny!
    Will you hold and play for the March expiration or will you cash out?

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  4. Occasionally we get lucky and something like this occurs. I will likely continue with this covered calls position by selling the Mar2011 $4.50 options on Monday.

    ReplyDelete