ITM Covered calls - Sprint

I noticed a good ITM covered call opportunity that can yield up to 40% annual ROI.
The company is Sprint. It has a market cap of $9.7 billion and revenue of $33.6 billion over the last 12 months.

In 2005 Sprint merged with Nextel to become the 3rd largest wireless company based on subscribers after ATT and VZ. However, the merger did not go well as the 2 management could not work together. Less than 3 years later, Sprint wrote off nearly $30 billion from the acquisition. This made it one of worst takeover in history. The company’s fundamentals continued to deteriorate with high debt, few new products pushing Sprint to a market cap of less than $10b.

But Sprint seems to be making a turnaround:

- Customer service has improved. Recently, its customer service ranked higher than ATT according to JD Power and Associates
- Sprint has been able to pay down $1.4b of its $21 b debt over the past year. Now it has $19.6 b in debt and $4.6 b in cash. The debt is still scary but on closer scrutiny, only $4.5 b is due within the next 3 years. Sprint has enough cash to service the debt. Sprint has generated $1.5 billion in free cash flow on first half of 2009. If the company is able to generate half that amount over the next five years, cash flow plus the current cash would cover debt payments until 2014.
- Spring is releasing new products. It sold more than 820000 Palm Pre phones and also release HTC Hero smartphone which uses google Android operating system.
- Spring launched “Boost Unlimited” in January. This prepaid Service allows customers to use a cell phone without signing long term contract. It costs only $50 a month. Management said it added 770,000 subscribers. It is the highest of prepaid performance by any US carrier. It is believed that Sprint is now gaining net subscribers after a long period of losing customers due to poor servce.

Sprint is trading at 60% discount to book value with a P/E of 4.5. This stock is cheap compared to similar stocks in the segment.

Finally, there were buy out rumours of a buy out last year which turned out to be false. It is my belief that this is a high probability. The possibility of a buy out and a big discount to the book values limit the downside of this stock.

There are few possible trades for this stock.

1. A married put which will capitalize on the potential upside
2. A ITM covered call with a SC in May which will give an estimated ROI of 40%


No (1) strategy is more aggressive. It will maximize profits if Sprint really sprint from this level. At the same time, it gives downside protection especially with earnings next month.

No.2 is a conservative strategy. If the trade is held till May, it gives an annual ROI of 40%.

I have decided to go for a conservative strategy. If the stock starts to breakout above 4.2, I will enter a new trade for an OTM covered call or married put.

Stock is showing some support at around $3.5

o BTO 10,000 stock at 3.63
o STO May 3.5 SC at .56

Cost basis: 3.07
ROI – 14% ( annual 42% )

PE: Let the SC be assigned at maximum ROI

SE: If stock falls below 3.07, roll down the short call to 3. If fundamentals change and deteriorate, add a protective put and convert the trade into a collar.