The Big News That Could Send This Cheap Stock Soaring

Mortgage lending fell to a 17-year low of $1.1 trillion in 2014 as tightening credit standards limited growth in new loans. Housing sales dropped for the first time in four years, down 3% to 4.9 million.

#-ad_banner-#There has also been a shortage of homes for sale, with 2 million houses on the market in November, up from a monthly average of 1.8 million in 2012 and 2013, but well under the 2.5 million monthly average between 2001 and 2006. Part of the reason for this is that buyers were underwater or barely breaking even on their current mortgages, so they lacked the equity to sell their home and buy a new one.

With news like this, you might not think it’s the best time to start buying into housing-related stocks. But you may have missed one headline that could mean a stronger housing market this year, especially for one segment in particular.


Housing Boom 2.0 With 97% Loan-to-Value Option

In December, Fannie Mae (OTC: FNMA) announced that it and Freddie Mac (OTC: FMCC) would begin offering a new lower-down- payment option. The 97% loan-to-value (LTV) program allows qualified first-time homebuyers to put as little as 3% down. 

The news largely escaped the media’s attention but could be huge for the housing market. 

Fannie and Freddie are government-sponsored entities (GSEs) that guarantee 69% of new home loans in the country. Previously, they would only back mortgages with a LTV of 80% or lower. 

Not only are the GSEs ready to open up the credit spigot to a ton of buyers, but rising home prices have helped to decrease the low-equity problem. 

The number of homeowners with between 10% and 20% equity in their homes increased by 1.2 million in 2014 on an eight-year high in home prices. With more people getting out from underwater on their mortgages, they can sell without taking a loss, which should boost supply

In short, the market is about to get a double shot. Not only are people seeing a better opportunity to sell their home because of rising prices, but the available pool of buyers is about to increase thanks to lower-down-payment requirements.

The Secret Beneficiary of the New LTV Rules

While the entire housing market could have a very good year in 2015, one sector in particular could see revenue jump on the new LTV rules. While the GSEs have agreed to buy loans on a 97% LTV, they are still requiring mortgage insurance on the loan if it is above 80% of the home’s value. With the previous LTV requirement at 80%, many people didn’t need to buy mortgage insurance. 

MGIC Investment Corp. (NYSE: MTG) is the nation’s oldest private mortgage insurer and holds $162.4 billion in policies. 

Like all mortgage insurers, the company saw its stock price absolutely destroyed in the housing bust. Shares have rebounded from their 2012 low below $1 to a current price near $9. But they are still relatively cheap at 9 times 2015 expected earnings.

Even on the slowing housing recovery in 2014, losses on defaults were down 41% in the year to September. 

MTG has captured about one-fifth of the market share, making it the third-largest mortgage insurer, behind only United Guaranty and Radian Group (NYSE: RDN). MTG is more efficient than its competitors, though, with a lower expense ratio, which is the percentage of insurance premiums used to pay for an insurer’s expenses. It also trades for a cheaper earnings multiple than its industry average. 

Sales are expected to increase 6% in 2015 to $998.5 million, but I think the company could surprise on the upside with increased home buying driving the need for mortgage insurance.

Rather than buying shares outright, I’m going to use a put selling strategy that will allow us to collect income upfront and potentially purchase shares at a discount to their current price.

By selling a put option on this stock, we are agreeing to buy 100 shares per contract at the option’s strike price if shares are below that price when the option expires. For accepting the obligation, we are paid a premium, which lowers our cost basis. If shares are above the strike price at expiration, that premium is ours to keep free and clear.

With MTG trading for $8.88 at the time of this writing, we can sell the MTG March 9 Puts for a limit price of $0.50 a share ($50 per contract).

If MTG does not close above the $9 strike price, which is 1.4% above the current price, at expiration on March 20, we will be assigned shares. Since we received $0.50 in options premium, our actual cost is $8.50 per share, a 4.3% discount to the current price.

We want to make sure we have enough money in our account to cover the potential purchase. This means setting aside $850 for every put contract we sell, plus the $50 we collected from selling the puts.

If MTG closes above $9 on expiration, we keep the premium for a gain of 5.9% in just 54 days. If we were able to make a similar trade every 54 days, we would generate a 40% annual rate of return.

The company announced fourth-quarter earnings on Wednesday of $0.19 per share, up from a loss of $0.01 a year ago, and beating the consensus estimate. There will not be another earnings catalyst until April, after our puts expire. By then, if we have been assigned shares, we are likely to see evidence of the rebound in housing, and sales could come in stronger than expected. If we do not yet hold the stock, we can continue to bring in income by selling put options.

Selling puts is one of the best ways to generate a consistent, high-income stream. For example, one of my colleagues used it to bring in $343 in cash on another insurer, $360 on a leading biotech company and $498 on a pharmaceutical company that was scooped up by another firm. This was all without buying a single share.

These were just a few of the trades she made on her way to a perfect 78 for 78 track record (see all of her closed trades here). In fact, her average annualized gain was 43%. If you want to get in on her next trade or simply learn more about using this strategy to bring in instant income, follow this link.