Email – #470

That seems to be the leading sentiment of American Express (NYSE: AXP) credit card holders.

Unlike its real credit card competitors, Visa and Mastercard, Amex is a liability-ridden company facing a major slowdown in spending from its holders, and a major upsurge in bad debts. Amex is a bag-holder when its users default, which makes it more like a bank in one sense, whereas Visa and Mastercard are more like transaction enablers.

Amex share price has surged in the past few weeks, almost doubling along with the other banks in the financial sector. While Amex isn’t about to go out of business, there is a lot of doubt regarding its profitability in the months ahead. The banks as a whole are in a very murky environment, but what is worse for Amex is that it has exposure directly to the high end consumer, the travel industry here and overseas, and to a huge pool of members who are turning delinquent at a rapid pace.

To counter some of this liability, Amex has pulled back on the spending limits offered to some users, and even gone as far as paying other card holders to turn in their card for a cash bonus just so Amex can reduce some risky exposure. These are smart moves, but also work to reduce the base of cardholders at a time when shrinking revenues are also putting pressure on the company.

Some of Amex’s biggest spenders are also under pressure as expense account spending by high rollers is no longer in vogue. Company junkets are down sharply. And because so much of Amex’s branded business is not based on revolving credit, its customers are facing pressures to pay down card balances at a time when many are looking for ways to manage their expenses and debts by acquiring credit.

We are going to take a LEAP PUT position on Amex just as soon as there’s another downturn in the banking sector. It’s moved up too fast in recent weeks and is ripe for a correction. As a bonus we’ll look for continued weak economic data and weak guidance from Amex. If both these conditions occur, we could see a steep slide in share price.

So, we’re not interested in buying an in-the money put option on this position, since it is too expensive. Rather, we’ll go way out of the money and buy the American Express January 2011 $10 puts (VAX MB) currently trading for $2.25 on the offer. We’re looking for a 20% to 40% decline in share price from the current $20 level in the next few months. That decline should be enough to produce profits of 30% to 60% on our LEAPS. We don’t intend on sticking around until expiration.

Buy the American Express $10 Put LEAPS (VAX MB) and do not pay more than $2.25. In fact with the spread at $1.95 by $2.25, you should be able to get filled at $2.25 or less.

Karim