A lot of money is left on the table, especially in options, because of emotional bias. No matter if you’re talking about some supposedly unbiased algorithm – which is coded by a real human – or expert traders and fund managers… bias is everywhere.
Of course, saying this isn’t really anything new. We have all known our share of premature selling or missing out on great buys because we felt like action or inaction made sense. But that’s not exactly what we’re talking about here.
You see, another fallacy investors often make is by assuming good companies, with tremendous growth potential can’t have bad periods. Of course, we all know that can happen. In fact, when a good company is going through one of these down periods – where either sentiment or outside pressures have too much influence on share prices – they often represent great times to buy.
But there’s also money to be made before those downturns… or even periods where rallies cool off for a bit. Today, we have just such an opportunity.
American Tower Corp (AMT) is on fire… in a good way. It is the single-largest independent owner of real estate and equipment in the communications industry.
It isn’t Verizon, AT&T, Vodafone or any other telecom. But they all use AMT’s vast properties for their towers. In many cases, they lease their towers and infrastructure directly from AMT.
So, when you see commercials bragging about “America’s largest network” or the “fastest-growing 5G grid”, AMT is a big part of it.
This fact, along with the company’s insatiable appetite for growing its own reach, has helped the company grow its top line 56% in just the last four years. Its net income has nearly doubled in that period.
Things are going so well for the telecom infrastructure giant that it has been able to grow its dividend by more than 100% in that same time period… giving investors a relatively safe way to profit from booming technology – including the huge investment money going into 5G tech – while also collecting a growing income check.
No one is disputing that AMT is doing well and has a solid foundation and high growth prospects. In fact, analysts are expecting continued growth for the foreseeable future:
But even here, you can see revenue to taper off this year before jumping back up. Most of that is actually due to a one-time cash infusion in Q4 of 2018 from a settlement it received from an Indian telecom company. In any case, this near-term flattening of sales hasn’t deterred investors.
Shares are up 18% so far in 2019 and 28% over the last 12 months. This is a hot stock.
However, as noted above, just because a stock is solid and doing well doesn’t mean it won’t have its share of dips and bumps in the road.
Earlier this week, AMT announced it was able to refinance $1.2 billion in debt for between 3.4% and 4%. That’s actually quite a deal for the company. But it also opens up its one less-than-sunny side.
The company has $18.4 billion in debt. That compares to just $1.2 billion in cash on hand.
Sure, it has the assets to somewhat justify that debt load… and it is a REIT, which usually carry such high debt. But it exceeds even those standards. It currently has three times the amount of debt to equity. That’s a scary proposition with interest rates so uncertain these days.
The refinancing of a small portion of that debt helped. But it’s still a drop in the bucket. And after its recently historic rally, investors may start taking note of this not insignificant issue.
Analysts have already picked up on it… downgrading it left, right and center from “buy” to “hold”.
There’s a way to play this potential problem… or at least the expected dip in share price. With the company’s debt in the news and investors looking to trim risk right now, AMT could see a slight correction… at least for a few months until growth picks back up.
This let’s traders use one of our favorite options strategies. Let’s look at it now…
A Strategy For a Short Term Dip
A bear put spread is a type of trade that uses two put options. It lets traders profit off relative small decreases in share price without taking on a lot of risk.
The way it works is by buying a near-the-money put option and selling an out-of-the-money one. This creates a net debit. But that entry cost is the only amount of money at risk during the duration of this kind of trade.
The put option the trader sells helps offset the cost of the bought one. This leaves the gap between the two strike prices as the profit opportunity.
You can see how this plays out:
Source: The Options Industry Council
The risk, as noted is set at the beginning… the entry price. The potential profit is also set right at the start of the trade. To find that take the difference in strike prices between the two put options and subtract the entry cost.
To see exactly how this kind of trade works… and why it should work so well for AMT, let’s look at a specific example.
A Specific Trade For a Short Term AMT Correction
A trader looking to use this strategy to profit off any small dip in AMT’s share price could buy an April 18 $185 put for $2.55 per share and sell an April 18 $180 put for $1.25 per share for a net debit of $1.30.
Each option contract represents 100 shares of AMT. So, the total cost – and therefore, total risk of this trade – is $130.
To find the maximum profit potential in this trade, take the difference in strike prices ($185 – $180 = $5) and subtract the cost ($5 – $1.30 = $3.70). Again, on 100 shares, that’s a maximum return of $370.
In other words, that represents a potential 285% return on the amount at risk. You’d be hard pressed to find that kind of risk-return ratio anywhere else. Of course, the stock does have to fall before this return could be realized.
To see exactly what that threshold is, take the strike price of the bought put and subtract the entry cost ($185 – $1.30 = $183.70). From its current price of $186.90, that represents a decline of just 1.7%. To max out the profit on this trade, shares would have to fall below $180, or 3.7%.
That’s quite achievable considering those shares are already up 18% year to date. A 3.7% dip is hardly a move worth talking about.
— The Option Specialist