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Discover Financial Traders Predict an About-Face

DFS attracts front-month skeptics despite strength

by 9/4/2012 2:01 PM
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Bearish speculators have piled on to Discover Financial Services (NYSE:DFS - 38.77) today, as more than 6,300 puts have changed hands so far, reflecting seven times the security's anticipated intraday volume. By contrast, only 166 calls have been traded.

Garnering notable attention has been the out-of-the-money September 37 strike, where more than 5,200 puts have been exchanged -- most of them at the ask price, suggesting they were bought. These contracts crossed at a volume-weight average price (VWAP) of $0.30 each. Meanwhile, implied volatility was last seen three percentage points higher. Currently, this option holds open interest of just 830 puts, underscoring our theory of new positions. In order for traders to collect a profit from these bought-to-open puts, the stock must breach $36.70 (strike price minus VWAP) by front-month expiration.

Today's uptick in put volume goes against DFS' bullish grain, as traders on the International Securities Exchange (ISE), Chicago Board Options Exchange (CBOE), and NASDAQ OMX PHLX (PHLX) have bought to open more than 14 calls for every put during the past two weeks. In fact, this 10-day call/put volume ratio of 14.50 is docked just three percentage points below a yearly peak -- meaning speculators have been snapping up calls over puts at a near annual-high clip.

It should be noted, however, that short interest on the banking firm rose by close to 7% during the last two reporting periods, implying that some of the recent call volume could be attributable to skeptics looking to hedge their pessimistic positions. Even so, DFS' bearish camp is far from crowded, as these shorted shares make up less than 2% of the equity's available float.

Meanwhile, the stock is feeling the love of the brokerage bunch. DFS sports 13 "strong buys" and one "buy" endorsement, compared to three "holds" and not a single "sell." Despite these lofty expectations, Thomson Reuters shows an average 12-month price target of just $38.70 -- representing a discount to Friday's closing price of $38.73. This leaves plenty of room for price-target hikes, which could create a tailwind for the equity.

DFS has certainly earned some technical bragging rights lately, as it boasts a year-to-date gain of roughly 62%, as well as a 52-week climb of about 60%. What's more, the security has blazed past the broader S&P 500 Index (SPX) by north of 11 percentage points during the last three months. A look at the charts shows that the stock remains perched atop its 10-week moving average -- a trendline that has not been breached on a weekly closing basis since early June. If the shares keep up this positive momentum, today's bears could be scrambling to exit their positions ahead of September expiration.


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