AGNC Unusual Option Activity Report

It’s been remarkable how well corporate bonds and mortgage REITs like AGNC Investment Corp (Nasdaq: AGNC) have held up amidst the route in Treasury bonds. As the 10-year U.S. Treasury yield approaches 1.5%, the perception of risk potential may be finally changing. This change is bearish for riskier assets like corporate and mortgage bonds, but also for risk assets generally. Today’s bearish option activity in AGNC is an indication that traders are noticing, and the reversal may be on the horizon.

AGNC Risks

If you’re not familiar with the potential risk in mortgage REITs like AGNC, let’s take a moment to get you up to speed.

Interest Rate Risk

This risk is inherent with a rise in interest rates. If current mortgage bonds being originated at higher yields than the company is holding, the value of the current portfolio of bonds at lower yields fall. The rise in Treasury yields is going to cause new mortgage rates to be higher, causing a company like AGNC to experience paper losses.

Reinvestment Risk

This may not be a huge issue right now, but it has impacted much of the current portfolio of mortgage bonds. The major trend in refinancing has caused mortgages at higher yields to be paid back prematurely. That means that mortgage REITs have to reinvest the money in lower-yielding bonds. This has the effect of lower the yield of the assets and increasing the risk.

Default Risk

The fact that we’re in a recession currently is something that the bond market has failed to fully acknowledge. Certainly, the massive injection of liquidity by the Federal Reserve has papered over the risks, but these risks will materialize at some point.

Borrowing Costs

Mortgage REITs are susceptible to rising borrowing costs. The fact that AGNC pays an 8.8% dividend yield is interesting since mortgage bond yields are at near historic lows. With so many mortgages below 3% and the return on these bonds less than that, how does a company like AGNC pay such a high dividend?

The company takes the predictable payments from the bonds and leverages it. That means that they take the money being added to the REIT and uses the capital to borrow more money to buy bonds. Even a relatively small change in the borrowing costs of this company and other like it can have a big impact on the income the company is generating for investors.

The fact that Treasury yields have risen significantly since the beginning of the year will eventually trickle down to higher borrowing costs. The recent weakness in high yield credit is an indication that it may finally be taking hold.

AGNC Option Activity

The option activity in AGNC has been sizzling today at over 3.3 times the average. The bulk of the unusual option activity has occurred on the put side with over five times the average volume at the time of this writing. The current put-to-call ratio is 1.293. Looking at the composition of the activity shows that 53% of the put volume was filled at the ask. Here’s a breakdown of the significant activity:

• 5,800 18 JUN 21 $15 puts mostly BOT @ $0.40 to $0.47 against open interest of 1,375

The long activity kicked in about 90 minutes after the open and is an indication of bearish interest in the stock in the coming months.

AGNC Technicals

Since last fall, it seemed like AGNC was in a position where the potential for a large decline was inevitable. At least, the potential returns were asymmetric as the upside was much more limited relative to the downside. Since November, the path of the price has been able to achieve higher highs and lows. While that is an indication of an uptrend, the convergence of the highs and lows shows more limited potential to advance.

(Click on image to enlarge)

The pattern of highs and lows on AGNC is a pattern called a rising wedge. While the pattern hasn’t broken out yet, the current interest rate landscape is certainly helping to entropy to build, which would be manifested in a decline in the price. The potential target on a breakout is $13.50, which is near the October lows, but the move could be much bigger if the risks are realized more fully.

Conclusion

There are a lot of factors that are stacking up against mortgage REITs like AGNC. This industry has proved resilient but the risk is palpable. While the option activity isn’t a catalyst, it is an indication of sentiment starting to turn. Also, the over 3% decline at the time of this writing helps to confirm the bearish option interest.