Options Trade of the Week 
Discover Financial Services (NYSE:DFS) Calls 
Monday, October 20, 2014

**OPTIONS TRADE OF THE WEEK: Buy the DFS Jan 2015 60.000 call (DFS150117C00060000) at or under $4.00, good for the day. Place a protective stop loss at $1.60 and a pre-determined sell at $7.00.

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by Ian Harvey

October 20, 2014

Introduction

**DFS Provides A Nice Dip To Profit From! **

Discover Financial Services (NYSE: DFS), a direct banking and payment services company, will report the results of its third-quarter after the close on October 21. Headed into the quarterly report analysts have forecast earnings of $1.34 per share on revenues of $2.2 billion. The stock has been trending lower with the overall market during the last couple of weeks, but remains up 12.3% on the year.

Like all the financials, Discover has pulled back in recent weeks, but the stock is still enjoying a nice gain for the year, and it is expected that an upbeat earnings report will ensue, which will keep strength under the stock. Consumer confidence has weakened a bit since the summer, but in August it was running at levels not seen since before the recession, which should translate to higher credit card usage.

Technical Oulook

Discover Financial Services has a 1-year low of $50.22 and a 1-year high of $65.98. The stock’s 50-day moving average is $63.64 and its 200-day moving average is $60.81. The company has a market cap of $28.846 billion and a P/E ratio of 12.13.

Earnings

Discover Financial Services last issued its quarterly earnings data on Tuesday, July 22nd. The company reported $1.35 EPS for the quarter, beating the Thomson Reuters consensus estimate of $1.30 by $0.05. The company had revenue of $2.17 billion for the quarter, compared to the consensus estimate of $2.16 billion.

During the same quarter in the prior year, the company posted $1.20 earnings per share. The company’s quarterly revenue was up 6.4% on a year-over-year basis. On average, analysts predict that Discover Financial Services will post $5.33 earnings per share for the current fiscal year.

For the upcoming report analysts project a profit of $1.34 a share, a rise from $1.20 per share a year ago.

Over the past month the consensus estimate has gone up, from $1.33, but it’s the same as the estimate from three months ago. For the fiscal year, analysts are expecting earnings of $5.32 per share. After being $2.34 billion a year ago, analysts project revenue to drop 6% year-over-year to $2.20 billion for the quarter. For the year, revenue is projected to come in at $8.69 billion.

The rise in profit in the second quarter came after profit dropped in the previous quarter. The 9% profit increase in the most recent quarter brought the figure to $644 million. One quarter prior, net income was down 6% year-over-year.

For the last two quarters, the company has seen an uptick in revenue. In the second quarter, revenue increased 5% to $2.45 billion from the year earlier quarter. In the first quarter, the figure rose 3%.

The majority of analysts (79%) rate Disco as a buy. This compares favorably to the analyst ratings of eight similar companies, which average 68% buys.

Growth Drivers

• An improvement in consumer spending, wallet share and credit quality trends are expected to lead to a positive earnings surprise in the quarter.

• Additionally, reduction in interest rate for student loans past quarter and introduction of an in-school repayment product, aimed to draw in a greater number of students, was successful and is expected to draw a greater number of students, thereby increasing Discover Financial’s student loan originations.

• Moreover, the company provided 5% Cashback Bonus on gas purchases through Discover More and Discover it card during the third quarter, which should draw more customers and thus contribute positively to earnings.

The positive trend is seen in the trailing four-quarter average surprise of 4.59%, which was greatly aided by the 3.85% surprise in the last reported quarter. This was possible because of loan growth and share repurchases on the part of Discover Financial.

Analysts Opinions

Discover Financial Services‘s stock had its “buy” rating reissued by research analysts at Buckingham Research in a report released on Thursday, 9th October. They currently have a $72.00 target price on the stock, up from their previous target price of $70.00. Buckingham Research’s price objective suggests a potential upside of 11.06% from the stock’s previous close.

The company has also been the subject of a number of other research reports:-

• Analysts at Oppenheimer reiterated an “outperform” rating on shares of Discover Financial Services in a research note on Tuesday. They now have a $73.00 price target on the stock, down previously from $74.00.

• Separately, analysts at Zacks reiterated a “neutral” rating on shares of Discover Financial Services in a research note on Friday, September 26th. They now have a $67.00 price target on the stock.

Three research analysts have rated the stock with a hold rating, thirteen have issued a buy rating and one has issued a strong buy rating to the stock. The stock has an average rating of “Buy” and a consensus price target of $69.05.

Conclusion

By looking at American Express (AXP), which has already posted its earnings, a look forward can be ascertained as to the likely earnings of DFS. AXP topped estimates, with results benefiting from a surge in consumer spending. Card spending rose 9% year over year, and I expect similar improvements for Discover.

Also, Discover Financial Services looks to be shaping up quite nicely for their report. This is due to the fact that Discover Financial Services is seeing favorable earnings estimate revision activity as of late, which is generally a precursor to an earnings beat. Analysts have been raising estimates right before earnings -- with the most up-to-date information possible -- which are pretty good indicators of some favorable trends underneath the surface for DFS in this report.

Look for an upbeat report, with the stock trending higher following the report. By looking at the recent dip in share price, it is an excellent buying opportunity, and will certainly help this options play.

Therefore, based on the facts above the following options trade is recommended…..


**OPTIONS TRADE OF THE WEEK: Buy the DFS Jan 2015 60.000 call (DFS150117C00060000) at or under $4.00, good for the day. Place a protective stop loss at $1.60 and a pre-determined sell at $7.00.


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