Lots of sound reasons behind COF's 8% move today
Will get hammered next week, now that Mar puts are done
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Charging Into Credit Card Options
Jocelynn Drake, Option Advisor 03.20.08, 5:35 PM ET
The initial public offering market provided investors with a little ray of sunshine this week with the successful launch of Visa. The well-known credit card company busted out in a big way, as the shares priced above their expected range at $44 per share, taking the top spot as the largest U.S. IPO ever.
As demand for Visa shares was extremely high, the firm announced Thursday that underwriters exercised their 10% over-allotment option to purchase an additional 40.6 million shares of its Class-A common stock at $44 per share. This is in addition to the original offering of 406 million shares.
Visa now expects net proceeds from the offering (including the over-allotment option, and after deducting underwriting discounts and commissions and estimated offering expenses) to be approximately $19.1 billion--well above the $11 billion record set by the AT&T Wireless IPO.
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On its first day of trading, Visa jumped more than 28%; it continued its rally Thursday, adding another 13% to the share price. However, concerns linger that hopes may be too high for the security. Heading into the company's IPO, Wall Street analysts and pundits were singing the company's praises. Analysts called the stock "priceless," a "ray of hope for the IPO market," and a "gift for the market."
From a contrarian perspective, this exuberance on an untested stock raises a red flag: Can the stock actually live up to these high hopes? If it can't, there is a significant danger of a sharp pullback as disappointed investors sell off their shares.
So, the question becomes: What opportunities are there in the credit card industry?
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One of the reasons for the high hopes on Visa lies with its rival MasterCard. Since MasterCard's IPO in May 2006, shares have skyrocketed nearly 400%. Furthermore, the shares have not suffered the same sharp pullback in 2008 as the rest of the market at large or the financial market in particular. Since the beginning of 2008, the stock has tacked on roughly 2%, while the S&P 500 Index (SPX) has dropped more than 11%.
The equity has entered a sideways consolidation phase as the stock digests some of its long-term gains. We saw a similar consolidation phase from May through October 2007, when the stock was stuck below resistance at the $170 level. After breaking above $170, the stock went on to gain roughly 33% before peaking again at $227.18.
Meanwhile, investors are extremely skeptical of the shares despite their outperformance. Short-sellers are attempting to call a top to the stock's uptrend, as more than 8% of the company's float is sold short. This accumulation of pessimistic positions represents potential sideline money for the shares. Furthermore, options speculators have loaded up on put positions.
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The Schaeffer's put/call open interest ratio for MasterCard rests at 1.15, as put open interest outweighs call open interest among options that expire in less than three months. This reading is also higher than 91% of all those taken during the past 52 weeks. Simply put, short-term options speculators have been more pessimistically aligned toward the shares just 9% of the time during the past 12 months.
Should the stock break out of its current sideways channel to the upside, these bears could scramble to jump on the stock's bandwagon, adding more fuel to MA's uptrend. Considering the equity is still in its sideways trend, options players may want to consider a longer-term option. A July $210 call or an October $210 call would allow an investor to benefit from such a rally.
Now, not everything is quite so rosy in the credit card industry. One company that has struggled is Discover Financial Services. Wednesday, the firm reported fiscal first-quarter earnings dropped to $81.2 million, or 17 cents per share. Earnings were partially hurt by a loss from discontinued operations related to its Goldfish business. Earnings from continuing operations came in at 50 cents per share. Analysts had expected a profit of 40 cents per share.
The shares of DFS dropped Wednesday on credit-quality concerns. The firm's loan-loss provision climbed 54% to $627.1 million and delinquency and charge-off rates continued to climb. One big difference between Discover and MasterCard is that Discover actually takes on the debt incurred when its customers use their credit cards. On the other hand, MasterCard and Visa don't take on this debt risk; instead, the lenders actually providing the credit cards with the MA or V logos take on that debt.
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Technically speaking, Discover's shares have declined since their IPO in July 2007. The stock's steady downtrend has resulted in a loss of more than 40%. While the equity broke above resistance at its 10-week and 20-week moving averages in trading Thursday, the security is still facing staunch resistance in the area of $17 to $18. This area has capped the stock's rally attempts since November. A rejection here could result in a sharp decline for the shares.
One concern from a sentiment perspective is the rising optimism among short-term options players. The Schaeffer's put/call open interest ratio for Discover has plummeted from its near-term high of 1.89 on January 22 to its current perch of 0.87. This decrease in the ratio indicates options players have added call positions at a faster rate than put positions during the past few months.
This combination of growing optimism amid the stock's technical weakness has bearish implications from a contrarian perspective. Traders should consider a July $17.50 put to take advantage of a rejection at resistance in the $17 to $18 plateau.
Finally, American Express is also struggling. The stock has been trapped in a steep downtrend since July, shedding more than 32% of its value. The equity is currently battling resistance at its 10-week and 20-week moving averages. Furthermore, AXP has closed the past three months below its 10-month and 20-month trend lines, a feat not accomplished since March 2003.
Considering the stock's sharp decline, it should come as no surprise to find that options players are skeptical of the shares. The put/call ratio for AXP stands at 1.20, and is just shy of tagging a new annual high. However, the stock is still vulnerable to more downgrades, as only four of the 13 analysts following the company rate it a "sell."
The one concern for this bearish play is the stock's most recent performance: AXP climbed above its 10-week trend line Thursday. Traders should use a weekly close above resistance at the stock's 20-week moving average as a sign that it may be breaking out of its downtrend.
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