BAERISH BETS ON CREDIT CARD ISSUERS.

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Options Watch
Bearish Bets On Credit Card Issuers
Jocelynn Drake, Option Advisor, 03.13.09, 01:55 PM EDT
Bad debts are piling up and performance is suffering for issuers of plastic. Make money on the short side.
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As the economy weakens and unemployment grows, the credit card industry could be seeing just the start of a growing wave of trouble.

In February, Moody's (nyse: MCO - news - people ) Credit Card Credit Indexes reported that credit card charge-offs reached a new high of 7.74% in January. Charge-offs are credit-card loans deemed to be uncollectible. Furthermore, the increasing number of borrowers falling behind on payments means charge-off rates are almost certain to increase as the economy worsens.
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The January delinquency rate, which forecasts the charge-off rate, climbed to 5.94%, the highest in 17 years. The record high of 6.31% in January 1992 is likely to be surpassed in the months ahead, Moody's said. In addition, Moody's expects the charge-off rate index could move into double digits by the end of this year if unemployment keeps rising.

Meanwhile, payment rates, which have declined since early 2007, are near a five-year low. In January, the principal payment rate fell to 16.39%, about 2.7 percentage points below the rate in January 2008.
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NOTE:the record high of 6.31 in january 1992 is likely to be surpassed in the months a head.

Digging deeper into the sector, we find that American Express (nyse: AXP - news - people ) has been having a rough year, as the shares have retreated more than 29% since the start of 2009. The company recently offered a $300 incentive for some customers to cancel their accounts as the card issuer and payments processor struggle with surging loan delinquencies and reduced card use.

American Express has been guided lower by resistance at its 10-week and 20-week moving averages for a loss of nearly 80% since June 2007. While the stock recently bounced off support at the 10 level, it is in the process of rallying into staunch resistance at its 10-week trend line--a moving average above which it has not finished a single week since late September 2008.

Meanwhile, it's not surprising to find that investors are skeptical of the shares. What is surprising is that this pessimism appears to have reached a peak, and investors are now loading up on bullish bets in an effort to call a bottom to the stock's decline. The Schaeffer's put/call open interest ratio has dropped from its Feb. 25 peak of 1.88 to its current position of 1.34. During this time frame, call open interest among options slated to expire in less than three months increased by 54%, while put open interest rose by less than 11%.
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An uptick in call trading can also be seen on the International Securities Exchange (ISE) and Chicago Board Options Exchange (CBOE). During the past 10 trading sessions, 1.7 calls were purchased to open for every one put purchased to open. This ratio of calls to puts is higher than 88% of all those taken during the past year, pointing to a growing optimism among options players.

Meanwhile, short interest is on the rise. During the past month, the number of AXP shares sold short increased by 32.5% to 38.8 million shares. Should the bears continue this trend of adding to their pessimistic positions in the face of the stock's recent bounce, they could help pressure the security lower once again. To take advantage of a pullback in the shares, traders should consider the stock's July 15 put.

MasterCard (nyse: MA - news - people ) isn't much prettier than American Express. The stock has managed to post a 10% gain since the start of 2009, outperforming the broad market. However, the stock is facing staunch resistance at its declining 32-week moving average. This intermediate-term trend line has capped the shares since August 2008. The equity is facing additional staunch resistance at the 165 level, a region that has hindered the security's rally attempts since mid-October. A rejection at either of these key levels could send the equity sharply lower.

Despite the weak outlook for the credit card industry, Wall Street still has high hopes for the shares of MasterCard. Zacks reports that the stock has earned 13 "buy" ratings, five "holds" and three "sells." This bullish configuration leaves ample room for potential downgrades that could pressure the shares lower.

Furthermore, the average 12-month price target for MasterCard stands at $191.67, according to Thomson Reuters. This lofty estimate implies that analysts are looking for the shares to rally more than 22% during the next 12 months. Price-target cuts from this optimistic group could weigh negatively on the security.

Drilling down on the stock's open interest configuration, we find that peak front-month call open interest sits at the 170 strike, with more than 11,400 contracts. On the other hand, peak March put open interest sits at the 130 strike, with fewer than 3,300 contracts.

This preference for call positions over put positions indicates that investors have high hopes for the shares during the near term. Should the stock fail to overcome resistance at the 165 level, we could see an unwinding of optimism among traders, pushing the stock lower. To take advantage of continued weakness in the shares, trader should consider the stock's July 160 put.

Finally, we come to the new kid on the block: Visa (nyse: V - news - people ). The security started trading publicly on March 19, 2008, and it is now down 4.5% from its closing price on its first day of trading. The equity has been trapped in a sideways channel since October, capped by resistance at the 58 level.

In fact, the stock was recently rejected at this level and could now pull back to former support in the 46 or 42 regions. In addition, the equity is facing resistance at its declining 32-week moving average--a trend line that capped the stock at the end of February.
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Wall Street has largely shrugged off Visa's lackluster performance. The equity has earned 10 "buy" ratings, nine "holds" and just one lonely "sell" rating, according to Zacks. Any downgrades from this group could spell trouble for the stock.

In addition, the average 12-month price target stands at $65.26, according to Thomson Reuters. This estimate is a 20.6% premium to the stock's closing price on Thursday. Price-target cuts from this bunch could also create a fresh wave of selling pressure for the stock.

On the other hand, options players have flocked to the stock's puts in expectation of further losses. The ISE and CBOE have reported an increase in put trading. During the past 10 trading sessions, 1.7 puts have been purchased to open for every one call purchased to open. This ratio of puts to calls is at a peak, indicating that options speculators are extremely skeptical of the shares.

Furthermore, the Schaeffer's put/call open interest ratio for V stands at 0.6, up from its March 4 low of 0.49. During this time frame, call open interest increased by 2.7%, while put open interest swelled by 25.6%. Considering the stock's weak technical performance, this pessimism is to be expected.

Elsewhere, we find that short-sellers have increased their bearish bets. Short interest for Visa jumped by 43.7% during the past month to 17.9 million shares. This accumulation of bearish bets accounts for only 2.3% of the company's total float. A continuation of this trend could push the stock even lower during the near term. To capture a profit on weakness in the shares of V, traders should consider the stock's June 55 put.

Joseph Hargett is senior equities analyst at Schaeffer's Investment Research. Click here for more ideas and recommendations and to learn more about Bernie Schaeffer's Option Advisor.
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Reader Comments

The author hasn't a clue about the Credit card business. Visa and Mastercard have ZERO default/retail consumer risk...they DON'T lend a dime to any individual or business. They are strictly a proce [Read More]
Posted by jlinderman | 03/13/09 03:03 PM EDT
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