Arcángel de Jesús Montoya
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Arcángel de Jesús Montoya in Money Trafficking,

American Capital Agency's Options Are Undervalued Going Into Earnings

American Capital Agency Corp. (AGNC), a real estate investment trust (REIT), which primarily invests on a leveraged basis in agency mortgage-backed securities (agency MBS), is reporting earnings on Wednesday, July 27, after market close:

(Source: TD Waterhouse)

The company beat earnings estimates in 0% of time in the last eight quarters, underperforming or showing in-line results in 100% of time, and has seen moderate volatility in the market price of its stock over the last three months:

The market participants expect the following numbers over the next few quarters, including the upcoming one:

(Source: TD Waterhouse)

Note the wide volatility of expected financial results.

On the other hand, market data show that the August options are relatively cheap:

(Source: TD Waterhouse)

The monthly straddles (options with a strike price of $19.50) are worth around 3.5% of the current market price of the stock. Historically, the stock has been more volatile than that on a monthly basis over the last year:

(Source: Google Finance. Calculations by author)

As you can see, the stock has had a monthly standard deviation of 4.6% over the last 52 weeks, while the straddle expiring in a bit less than a month has an implied monthly volatility of around 4.3% (calculated based on 18 business days remaining until expiration), also including volatility from the earnings event this week. I therefore see signs of modest undervaluation in these options.

What do you think of this trade?