Minimal Risk/Maximum Leverage in Two-Way Communications Play (VZ, T)

We’ve got a great set-up for you today, using a communications pairing that pits Godzilla against Rodan in a 5G battle to the death.

It’s a trade that offers a potential return of $33.70 on an outlay of just $0.30!

Mathematics informs us that’s 11,233%.

So let’s get right to it.

BUT COULD IT BE…?

The essence of the trade is the wild discrepancy in performance over the last four trading sessions between AT&T (NYSE:T) and Verizon (NYSE:VZ), the behemoths of the American telecom scene.

Admittedly, traders were onto something when just last week they jacked up their purchases of T and dumped VZ.  But, alas, as it goes in this world of manias, addictions and hyperactive Twitter-schlock, the action went too far.

A look at how the two stocks have performed against one another shows the wild, bipolar mania that took over telecom last Thursday/Friday—

We don’t believe what happened is reality-based.

That is, the gap between the two stocks will very likely close, because the justification for the move was wanting, in our view.

What Happened, Huey?

In short, Verizon posted earnings, beating earnings and revenue estimates, but failed to gain a truck-load of customers in the all-important postpaid (monthly) category as fast as AT&T.

The market being what it is, Verizon’s punishment commenced, and the rewards were lavished ham-handedly on arch-nemesis AT&T.

Subscriber momentum is important, to be sure, and AT&T is certainly excelling in that metric.  But whether Verizon’s more pricey plans are the real reason for the lag is questionable.  And that’s where most are laying the blame.

Moreover, it’s not clear that AT&T’s outperformance in this area will continue.

What is clear, however, is that, technically, both stocks flipped out—and that’s what makes today’s trade so timely.

CHARTS!

[Fundamentals are somewhat irrelevant for today’s initiative, because the two companies share almost identical numbers.]

Have a look now at six months’ of VZ chartitude –

Technically, we have—

1. A 33% drop in price since the last retracement high in July, marked by a steep, down-sloping trendline (in red).
2. Price will have to cross above that line to establish a breakout, and there are some encouraging signs that we’re nearly there, including…
3. A bullish engulfing pattern (in blue) some ten days back, a reliable sign that a turn in price has occurred.
4. A massive surge in volume last Friday, a potential sign of a key reversal day.
5. RSI and MACD diverging higher against price (in green) – though just for the last eight sessions, so the jury’s still out on whether to ascribe great significance to this.
6. And finally, with all MAs unwound and trending lower (in purple) – and price trending at just two-thirds the value of the long-term MA – it appears a bounce is very close.
7. A gap through $45.50 (in black) suggests we could get a significant rise before the retracement concludes.

Now look at T’s action for the corresponding period –

Technically…

1. Price has snapped higher by 20% in just seven trading sessions (in red). For an old utility like AT&T to move in that fashion is rather obnoxious.  And that’s exactly what these telecoms are, by the way: utilities.
2. Three times the average daily volume was logged on the same day that Verizon tanked on massive volume.  The money left V and travelled straight to T.  Hence the exaggerated action on the charts.
3. The steepness of the vectors on both the RSI and MACD indicators (in green) also strike us as bizarrely overdone for legacy stocks such as these.  Saner heads will shortly see that value variety securities shouldn’t behave like a junior high hoodlum who forgot his Ritalin.
4. We’ve got massive overhead resistance from two falling MAs (black/yellow) and a gap to fill at $15.75 (in blue).  And it’s from those markers that we’re setting our trade.

The trade that emerges from all the foregoing, however, is dynamic.

That is, we’re going to make a recommendation, and then urge you to modify it according to your capacity for risk.

We’ll spell out the risk/reward profile at the extremes, then you’ll decide to insert yourself anywhere in between.  By all means, be in touch if you have questions.

Here—you’ll see what we mean…

A Jew and His Money recommends you consider short-selling T at $17.10, buying the T January 20^th 18 CALL for $0.50 and selling the T January 20^th 16 PUT for the same $0.50.  That effectively puts a credit of $17.10 in our pockets.  Next, buy ten (10) VZ January 20^th 35/40 CALL spreads* for $1.74 (2.09/0.35) each.  Total debit on the trade is $0.30.

[*Buy the 35 CALL and sell the 40 CALL.]

Rationale: listen good…

We’ve put the pedal to the metal on this one, betting with the full expectation that VZ is going to outperform T in the next 90 days.

Our max profit if both stocks perform as we’d like is $33.70 on just $0.30 spent (+$50.00 on the VZ side; –$16.30 from T).

That’s 11,233%.

Max loss in this scenario is $18.30.  And that’s not Monopoly money.

Which is why we’re also framing the trade from a minimal risk perspective.

And as you’ll see, it’s still very attractive.

Instead of ten CALL spreads purchased, consider buying just one.

The ensuing calculus yields the following—a maximum gain of $4.36 on nothing laid out (2806%).

And a maximum loss of $2.64.

Theoretically, the trade works as follows—

The T side of the trade provides us with three items: working capital of $17.10; a chance to profit by $1.10 on the downside; and a limited loss of $0.90 should the shares head north.

Beyond that, our personal risk appetite guides the trade.

You can sign on for anywhere between one and ten VZ CALL spreads, upping the potential gain AND RISK with each spread purchased.

Again, max and min profit/loss parameters have been provided above.

What are we looking for, essentially?

Roughly speaking, $1.74 (or more) in collective VZ gains and T losses will put us strongly into the black, regardless how many spreads we choose to purchase.  And that’s a likelihood we see occurring in spades.

Finally, the trade will likely be closed—or partially closed—once we see the expected narrowing of the gap between the two stocks.  We needn’t wait for expiry, though we’re prepared to do so if the action unfolds to our advantage.

That said, the whole affair could wrap inside a week.

And with that, we bid you all G-d speed and lots of mazal.

!השם ישמור אתכם

With kind regards,

Hugh L. O’Haynew

Follow @HughLOHaynew