This Credit Card Company Can Deliver Benefits
By: Steve Smith
Despite its platinum brand name this company’s shares have been tarnished through lost business and charges of unfair business practices. Can they resume their shine? Use this option strategy to generate short term income and benefit from higher prices over time.
It’s widely known stocks are discounting mechanism meaning current prices reflect future expectations. Sometimes, in fact many times, expectations prove to me wrong which is why share prices continually fluctuate in the short term often beyond the company’s long term fundamental value.
One of the best indicators that a stock may be at a turning point is when bad news fails to drive shares lower. I think has occurred with this credit card company whose shares have declined 15.5% thus far in 2015. At this point bad news seems to be fully priced in and shares should start charging higher; sorry couldn’t help the pun.
American Express (AXP) shares have been battered of late with the biggest blow coming February when it lost its deal as the exclusive card accepted at Costco (COST). Shares tumbled some 10% in the following days when investors realized that accounted for 12% of its cards and nearly 20% of its annual charges.
There are also larger secular forces at work as other digital payment platforms that have lower fees become more attractive alternatives especially for smaller merchants. In fact on Tuesday American Express lost a its bid to halt an injunction to prevent merchants from steering customers towards using lower fee cards and it could possibly face antitrust fines. That’s pretty bad news, right?
So it is interesting to note shares actually rallied over the next two days. The stock seems to have put in a bottom and is building solid base along the $78- $80 level.
I think this sets up a good situation to use an options strategy to both generate short term income and profit higher prices over time.
High End Problems
The fact is while the loss of the Costco account was certainly a blow in the short term it might have made good business decision for the long term. Remember American Express wasn’t fired, they decided to walk away from the contract when the giant retailer wielded its leverage to negotiate better terms. Amex management decided the slimmer profits weren’t worth taking on what might have been additional risk.
Much of what separates American Express from competitors is it services a wealthier customer base which leads to both higher per charge amount, about 2x both Visa and Mastercard, and higher balances which in turn generates a 29% return on equity and 18% profit margin; more than double the industry averages.
Its wealthier customer base also means it has the lowest default rate allowing it to keep low loan provisions. Its membership program has allowed it keep a loyal customer base and analysts now expect earnings growth to stabilize at 12%-15% over the next two years. At $80 shares currently trade at just 14x forward earnings meaning there is no premium being awarded. This valuation coupled with a decent 1.6% dividend not only should provide a floor but any increase in earnings could drive a substantial move higher in the shares.
I want to establish a bullish position through use a combination of the sale of near term put spread for a credit that will both generate income and also help finance the purchase of longer term call options.
First the put spread:
-Sell the July $77.50 put
-Buy the July $72.50 put
For a $0.60 net credit
Then purchase of calls;
Buy the October $85 call at $1.25 a contract
The total 3 strike combination being done for a $0.65 net debit.
The put spread being sold expire July 17th. The calls being purchased expire October 16th.
This is what the risk/reward graph and pertinent stats look like:
As you can see this position can make money in the short term even if shares stand still. And it greatly benefits if the stock rises over the next few months.