Option Trade 
Discover Financial Services (NYSE:DFS) Calls 
Tuesday, October 20, 2015

**OPTION TRADE: Buy the DFS Jan 2016 55.000 call (DFS160115C00055000) at approximately $2.45. Place a pre-determined sell at $4.50.

Note: No protective stop losses added as yet -- but if you wish to do so make it $1.00.

by Ian Harvey

October 20, 2015

Introduction

Discover Financial Services (NYSE: DFS), a direct banking and payment services company, will report its third-quarter results after the market closes on October 20th.

Analysts expect Discover Financial Services to post earnings of $1.32 per share and revenue of $2.21 billion for the quarter. During the same period last year the company earned $1.37 per share on revenue of $2.2 billion. The stock is down 16.6% on the year.

DFS trended lower through the latter part of the summer along with the overall market, but shares have started to rebound, and if the stock can break through resistance at $56.00, there is not much more resistance until around $59.00, so there should be a nice move higher on a better-than-expected quarterly report. The company has a pretty good earnings track record, reporting weaker than expected earnings just one time in the last 10 quarters -- and this time round, shares should head higher after the company reports earnings Tuesday, and bounce back from an underwhelming second quarter.

The company, which was recently named “consumers’ favorite credit card” in a J.D. Power study, is poised to benefit from its focus on attracting younger card users, who will continue to increase their buying power and overall transaction volume as they age. As consumers' favorite credit card, it seems likely that consumers will stick with Discover for longer, taking competition from other card issuers.

Last quarter, although Discover Financial Services posted a small year-over-year decline in profit, Discover still showed investors why they should stay with the company, as total loans continued to grow at an impressive pace, nearly 5% year over year, and personal loans increased more than 13%.

Wall Street is bullish on the stock, with 11 of the 15 analysts who cover it giving it a "strong buy" rating, and with a P/E of just 11.2, I see limited downside risk at the current time as long as Q3 earnings are at the least in-line with analyst estimates.

Technical Details

Shares of Discover Financial Services closed yesterday at $54.99. The firm has a market capitalization of $24.25 billion and a P/E ratio of 11.51.

Discover Financial Services has a 52-week low of $50.20 and a 52-week high of $66.75.

The stock has a 50 day moving average of $53.11 and a 200-day moving average of $56.57.

Earnings

Previous Earnings

Discover Financial Services last announced its earnings results on Wednesday, July 22nd. The financial services provider reported $1.33 earnings per share for the quarter, topping analysts’ consensus estimates of $1.32 by $0.01.

During the same quarter in the previous year, the firm earned $1.35 EPS. The business earned $2.18 billion during the quarter, compared to analysts’ expectations of $2.23 billion.

Future Earnings

Analysts expect $1.34 EPS, down 2.19% or $0.03 from last year’s $1.37 per share. DFS’s profit will be $583.39 million for 10.39 P/E if the $1.34 EPS becomes reality. After $1.33 actual EPS reported by Discover Financial Services for the previous quarter, Wall Street now forecasts 0.75% EPS growth.

Equities analysts expect that Discover Financial Services will post $5.26 earnings per share for the current fiscal year.

Why Discover?

Discover offer better customer service than rivals, such as Visa and Mastercard, and judging from the J.D. Power study mentioned above, Discover seems to be winning.

Furthermore, Discover trades at a very low price-to-earnings ratio compared to the industry, leaving it with very little room to the downside.

Discover is a "double-dipper" in that it can profit off of merchant payment facilitation and earn interest on outstanding credit loans. The ability to boost profits this way gives Discover a potential margin edge over other card providers when the global economy is firing on all cylinders.

Another point worth mentioning is that Discover's delinquency rates have been near historical lows. The percentage of credit card loans more than 30 days past due shrank eight basis points to 1.55% in the second quarter, and the net charge-off rate dipped five basis points to 2.28%.

Last quarter, Discover Financial made a strategic move by closing its mortgage origination business. This was directed to help the company focus on its profitable direct banking operations that form its core business. The company has also worked toward enhancing its customer base in the Card channel by collaborating with Alternatifbank (ABank) – a subsidiary bank of The Commercial Bank of Qatar Q.S.C. and also teaming up with Apple Inc. AAPL.

While the provision of enhanced benefits to card members through the association with ABank strengthens Discover Financial’s global presence, the collaboration with Apple signifies its incessant efforts to deliver safe and convenient payment solutions. Both the deals should make way for gaining increased members thereby boosting card usage. This should, in turn, lead to increased income for the company.

Moreover, the company remains adept in its capital deployment initiatives, reflected by the $2.2 billion share buyback program approved during the quarter. Increased buy backs should lower share count and hence, boost earnings per share.

Analysts Opinions

Although, Discover Financial Services had its price objective decreased by equities researchers at RBC Capital from $77.00 to $69.00 in a report issued yesterday, the firm still has a “top pick” rating on the financial services provider’s stock. And the RBC Capital’s price target points to a potential upside of 23.88% from the company’s current price.

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

• Bank of America reiterated a “buy” rating and set a $70.00 target price on shares of Discover Financial Services in a research note on Saturday, September 5th.

• Janney Montgomery Scott dropped their target price on shares of Discover Financial Services from $70.00 to $66.00 and set a “buy” rating on the stock in a research note on Friday, October 2nd.

• Vetr upgraded shares of Discover Financial Services from a “buy” rating to a “strong-buy” rating and set a $68.67 price target for the company in a research note on Monday, June 29th.

• Sterne Agee CRT initiated coverage on shares of Discover Financial Services in a research note on Wednesday, September 9th. They issued a “buy” rating and a $65.00 price objective for the company.

• Finally, Deutsche Bank restated a “hold” rating and set a $61.00 price target (down from $64.00) on shares of Discover Financial Services in a research report on Thursday, August 6th.

Five equities research analysts have rated the stock with a hold rating, seventeen have issued a buy rating and two have issued a strong buy rating to the company. The stock currently has an average rating of “Buy” and a consensus target price of $67.94.

Harvey’s Options Volatility Indicator

Conclusion

Discover remains poised to outperform, and this quarterly earnings call could be where Discover takes the next step. And if insider ownership is any indication, Discover will come out on top.

Therefore, based on the facts above, and Harvey’s Options Volatility Indicator, the following option trade is recommended…..

**OPTION TRADE: Buy the DFS Jan 2016 55.000 call (DFS160115C00055000) at approximately $2.45. Place a pre-determined sell at $4.50.

Note: No protective stop losses added as yet -- but if you wish to do so make it $1.00.

”Success is simple. Do what's right, the right way, at the right time.”

Option Tip for your Success!
Options traders are not successful because they win.
Options traders win because they are successful.



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