In a moment, I will tell you exactly how you can make some heavily leveraged gains as the stock of Capital One plummets.  But first, here’s an interesting true story.

Crystal is a single mother with three great kids.  Two years ago her mail box was stuffed with credit card offers.  Credit was so easy to come by then.  All she had to do was sign her name and mail back the application in the little postage-paid envelope.  A week or two later, her shiny new credit card arrived.

Crystal is a great mother, and her children are her pride and joy.  She owned her own home and always paid her bills on time… until she lost her job.

You see, Crystal had already tapped out her home-equity line of credit.  And the only way she could feed her kids was to buy groceries on her credit card.

Crystal’s credit card company was easy to work with… until she missed a payment.  That’s when she got hit with a $39 late-fee and her rate was raised to 29.4%.  Crystal wanted to pay her bills but she did the right thing instead, she fed her kids first.

The credit card company unleashed a vicious collection agency on Crystal that would harass her family and call at all hours of the night.  It got so bad that she had to file for bankruptcy to get the frustrating calls to stop.

In the bankruptcy, Crystal’s credit card debt was “discharged” by the judge, meaning the credit card company took the full hit and Crystal didn’t owe them any money.  At this moment, the good news is that Crystal still owns her home, her kids are great and she just landed a new job…

Stories like this are quite common in America today.  In fact, U.S. credit card defaults rose to a record high in May.  Consumers remain under severe stress and credit card losses across the industry are on pace to surpass 10% this year which would lead to write-offs of over $70 billion for credit card issuers.

Unemployment hit 9.4% in May, which is at the highest level since 1983.  If people don’t have jobs they can’t pay their bills.

Real estate prices have dropped so people can’t borrow against their home anymore–therefore they tend to run up their credit cards.  In fact, American households have been loading up on credit card debt like crazy, with balances rising 75% since 1999.  The average credit card debt per U.S. household is now well over $8,000.

Credit card issuers are attempting to protect themselves against defaults by lowering people’s credit limits and closing accounts.  They have also been hitting consumers with higher interest rates, jacking up fees and canceling reward programs.

But Uncle Sam is putting his foot down.  The U.S. government recently passed a law limiting credit card fees and interest rates.  This will stop credit card companies from socking-it to the American consumer.  But it will be even harder to get a credit card once this law goes into effect–and will increase defaults as consumers find it more difficult to refinance their debts.

Bottom Line:  Credit card issuers are doomed!  How can you play it?

Put options on the goliath credit card issuer Capital One could deliver you some hefty gains as their stock goes down.

You see, Capital One is still losing money hand over fist.  They had a net loss of over $111 million in the first quarter of 2009.  And they lost $46 million in 2008.

I expect Capital One’s revenues to continue to fall, due to slowing consumer spending and a troubled U.S. economy.

The company is in big trouble as a result of a continuing rise in delinquencies and charge-offs in Capital One’s credit card and home equity lines businesses.  Its credit card default rate rose to 9.41% and lower real estate prices have crushed their home equity line portfolio.

Plus, top rating firm Reuters has Capital One rated “Underperform”, and Standard & Poor’s rates the stock a “Sell”.

From a technical perspective, the 200 day moving average is falling which is bearish.  Furthermore, the Up/Down volume pattern indicates that the stock is under distribution, which means investors are offloading the stock.  See the chart:

Buy Put Options on Capital One Financial.

Please keep in mind that option trading is speculative.  Of course I can’t guarantee profits and losses are entirely possible. You should only invest funds you can afford to risk.

The high-powered, strictly limited-risk option I suggest trades under the symbol (YFNME).  I say limited risk because you can’t lose more than your initial investment.

One options contract will give you the option to sell 100 shares of the Capital One Financial stock (COF) at $25 per share.

This options contract (YFNME) gives you the right to sell (COF) until January 15th of 2010 at $25 per share.  If Capital One stock drops to $15 per share then you will have a minimum gain of 67%.  If it drops to $10 per share your gain would be 150% at the very least.

Here are the details for the option recommendation:

Option: January 2010 – 25.00 puts (YFNME)
Underlying symbol: COF
Breakeven point at expiration: $25.00 - $6.00= $19.00
Estimated Cost: $1,200 (2 contracts x 100 Shares x $6.00 premium)
Expiration date: January 15, 2010 at 4:00pm EST

After you have done your homework and if you agree with my recommendation, enter the trade online or call your stock broker and say:

“I want to BUY 2 contracts of Capital One Financial Corp. January 2010 Put Options, with a strike price of 25.00, symbol YFNME, at 6.00 points or less, to open.  This order is good ‘til cancelled.”

Close the position if the option trades 50% below your entry price.

Sell the first half of the position if the option trades 100% above your entry price.

Let the second half ride for maximum profits.

If you buy this position and the option is in the money you should exit this position on or before January 15, 2010.

Stock options give you the leverage you need in today’s fast moving markets.  I give 2 to 4 new options picks like this every month in my new options newsletter the Options Power Trader.  Click here if you would like to learn more.

Best Wishes,

Ted Peroulakis