Cautiously Join the Bulls Before DFS Reports

by Joseph Hargett | September 26, 2012 9:12 am

Cautiously Join the Bulls Before DFS Reports

Banking and credit-card stock Discover Financial Services (NYSE:DFS[1]), which has had a torrid run in 2012[2], might be facing pretty high expectations when it releases its third-quarter earnings figures Thursday morning.

On average, Wall Street is anticipating a profit of $1.04 per share on revenue of $1.9 billion. However, according to EarningsWhisper.com, the whisper number of Discover’s quarterly earnings arrives at $1.07 per share.

You can see further evidence of high expectations within the brokerage community. For instance, 15 of the 25 analysts following DFS rate the shares a buy or better, compared to just seven holds and no sell ratings.

There still is room for improvement, however, as the consensus 12-month price target of $40.95 represents a measly premium of only 7.8% to Tuesday’s close at $37.98. In other words, DFS analysts have little room for potential upgrades, but plenty of overhead for price-target increases.

Options traders also are considerably bullish ahead of Discover’s quarterly report. Specifically, the put/call ratio for the October and November series of options arrives at 0.46, meaning that call open interest more than doubles put open interest.

Peak October call open interest totals a hefty 8,389 contracts at the overhead 40 strike, while peak put open interest numbers 3,154 contracts at the deep out-of-the-money 31 strike. Other notable accumulations include the 3,474 contracts open at the October 39 call, the 2,366 calls residing at the October 38 strike, and the 1,312 contracts open at the October 37 put.

Taking a closer look, October option implieds are pricing in a post earnings move of about 6% — indicating a potential rally to about $40.30 or a drop to about $35.70. Those traders looking to join the bullish crowd ahead of Discover’s earnings report might want to temper their enthusiasm by entering a bull call spread instead of just buying calls.

With this strategy in mind, an October 38/40 bull call spread could potentially be quite profitable. This spread was last offered at 70 cents, or $70 per pair of contracts, placing breakeven at $38.70 — a gain of roughly 1.9% from Tuesday’s close.

A maximum profit of $1.30, or $130 per pair of contracts, is possible if DFS closes at or above $40 when October options expire.

As of this writing, Joseph Hargett did not hold a position in any of the aforementioned securities.

Endnotes:
  1. DFS: http://studio-5.financialcontent.com/investplace/quote?Symbol=DFS
  2. which has had a torrid run in 2012: http://investorplace.com/2012/08/discover-financials-crazy-climb-cant-continue-can-it/

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