I wrote an article on American Capital Agency (AGNC) on May 3 where I said the stock would continue to move up because there were no signs it would slow down. A short-term income trade I suggested at the time ended up working well. Here is the original trade I suggested:
Option Play From May 3, 2012
-- Buy a June 2012 call with a "32" strike (priced at $0.24)
-- Sell a June 2012 call with a "33" strike (priced at $0.06)
-- Net Debit to Start: $0.18
-- Maximum Profit: $0.82
Reasoning Behind This Trade
-- Single-family mortgage rates will continue to inch their way up, thus the company will increase profits.
-- AGNC is strongly bullish, showing no signs of slowing down.
The trade went well and I closed it out the first week of July with a nice profit. Since the trade, the stock has peaked. Will it continue back up? Does it still make sense to invest in this stock?
Quick Education on REITs
REITs generate income from "spreads" between interest they receive on mortgages and the borrowing costs they acquire from those investments. Sometimes mortgages use leverage to borrow at low short-term interest rates and lend at higher long-term rates. There is risk involved in this as interest rates start to rise -- they dig into the profits and perhaps the dividend to investors. One way to measure the "health" of the REIT is by the conditional prepayment rate. If this rate is high, the REIT needs to continue to reinvest in mortgages that pay lower rates. It could also mean that dividend rates could go down. The conditional prepayment rate is the percentage of principle that gets prepaid on an annualized basis over a period of time.
Is American Capital's Dividend Going to Come Down?
The company projected prepayment rates to increase from 9% in the first quarter of this year to 12% in the second quarter. Because of this, it is only a matter of time before the dividend has to get lower than the present 14.5%. Putting this prepayment news next to major competitors still makes AGNC look good. Annaly Capital Management (NLY) has a prepayment rate of 20%, so the company still looks good.
Is It a Good Time to Invest in the Company?
For income investors, it seems like it would still be a good choice as an investment. It would take a huge fall in the value of the stock before the company's dividends would end up in the high single digits. But this is still a good dividend, so if an investor is looking to create an income then I believe American Capital would still be a good investment.
But there are some things that investors should be aware of. Take a look at these stock offerings:
- Recent 32 million common stock offering
- 6 million preferred share offering in March 2012
- 62 million common stock offering just prior to this
- Stock offerings have occurred every year since its initial IPO
Obviously, this is a part of the company's modus operant. The management team is pretty solid and continues to put the money to good use. But there may come a time when diluting shareholder values through common stock offerings may see diminished returns. This is just something that an income investor should keep in mind.
I believe that new investors interested in value growth should go elsewhere because the growth rates we have seen in REITs may have hit a snag for now. Those who own the stock will still reap good income benefits for a while. I think the dividend will remain attractive for some time to come. But we may see the stock move down from its recent high from this point on.
Click to enlarge image.
After a four-month move up, the stock formed a double peak in July and since then has been struggling to define a trend for itself. Since it hit a low in early August, it has been on a short-term upward move. Can this continue? If we observe the Bollinger Bands, they have a slight downward lean and the stock has just reached the upper band. Normally, this means that the stock would start moving back down. I also noticed a contraction in the bands. So one of two things can happen here: It will either continue up and follow the upper band as it widens, or it will move back down now. As it has lately followed the 50-day moving average, another possibility will be for it to use the moving average as support. Both the RSI and the MACD are following the stock's movement and tell us nothing new.
The Options Trade
It's presently trading at $34.77, so I am going to put together a bearish option income play.
- Buy a December 2012 put with a strike price of "34.00" (priced at $1.92)
- Sell a December 2012 put with a strike price of "33.00" (priced at $1.35)
- Net Debit to Start: $0.57
- Maximum Profit: $0.43
- Maximum Risk: net debit
- Maximum Length of Trade: four months
Reasoning behind the Trade
- Dividend will possibly start shrinking.
- Value may have reached its peak as analysts are moving more toward being neutral on the stock.