This Trade Targets a 130% Potential Return by March

Editor’s note: In this new daily column, Rick Pendergraft shares one of his favorite option trades for the current market. Each trade offers defined risk and typically targets 100%-plus potential returns. Rick has been studying, trading, analyzing and writing about the investment markets for over 30 years. He has worked for some of the largest financial publishers in the world and he has been quoted in the Wall Street Journal, USA Today, the New York Times and the Washington Post. In addition, he has been interviewed on Bloomberg, CNBC and Fox Business News. Rick’s analysis process includes fundamental, sentiment and technical analysis.

Option Trade Of The Day: Invesco Mortgage Capital Inc. (NYSE: IVR)

It is rare to find option trading opportunities with REITs, but sometimes you find them and that is what I have for you today, an option trade on a REIT.

Invesco Mortgage Capital Inc., focuses on investing in, financing, and managing residential and commercial mortgage-backed securities and mortgage loans.

It invests in residential mortgage-backed securities (RMBS) that are guaranteed by a U.S. government agency or a federally chartered corporation.

The company is headquartered in Atlanta and was founded in 2008.

Analyzing REITs can be tricky as they don’t really have many costs, so their profit margins tend to be higher than most companies.

Even with that in mind, IVR has a profit margin of 89.6% which is high even by REIT standards. The company has seen sales grow by 72% annually for the last three years. The company also has a return on equity of 19.6%.

While the fundamentals for IVR are solid, it was what I saw on the chart that led me to this trade.

We see on the chart that the slow stochastic readings have dipped in to oversold territory four times over the past year. The most recent one just happened, but in each of the other three instances, the stock was at or just below its 50-day moving average.

Also in each of the three previous instances, we saw the stock rally at least 10% over the next five to six weeks. A rally of 10% from the recent low of $17.24 would put IVR at $18.96.

With that in mind, I give you this trade idea.

Buy to open, the February18 17 strike calls on IVR at $0.85 or better. If the stock moves up to $18.96, this option will have an intrinsic value of $1.96 and that would give investors a gain of 130% on these options. Given the previous rallies and the pattern, it doesn’t seem like too much to ask. My only concern with this trade idea is that there isn’t any open interest on this particular option at this time. Experience tells me that this can be an issue at times, but when the option is $0.59 in the money and the ask price is only $0.80 at this time, 75% of the premium is for intrinsic value and 25% is for the time premium for the next 40 days before expiration.

— Rick Pendergraft

OPTIONS DISCLAIMER: Options involve risk and are not suitable for all investors. Prior to buying or selling an option, a person must receive a copy of Characteristics and Risks of Standardized Options. Copies of this document may be obtained from your broker, from any exchange on which options are traded or by contacting The Options Clearing Corporation, investorservices@theocc.com.

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Rick Pendergraft, Trades Of The Day

Rick Pendergraft has been studying, trading, analyzing and writing about the investment markets for over 30 years. He has worked for some of the largest financial publishers in the world and he has been quoted in the Wall Street Journal, USA Today, the New York Times and the Washington Post. In addition, he has been interviewed on Bloomberg, CNBC and Fox Business News. Rick's analysis process includes fundamental, sentiment and technical analysis.