Playing The Pharmaceutical Option
Jay Kaeppel | Dec 18, 2019 02:07PM ET
Every once in awhile the implied volatility for the options on a given security goes – for lack of a better phrase – “Super Nova.” In essence, it soars to the moon. When this happens, the time premium in those options explodes and offer a tempting opportunity to option sellers. But the catch is that one has to be prepared for whatever risks are entailed.
So when implied volatility soars, an option trader who wants to take advantage must craft a position that can allow them to take advantage of time decay and/or a subsequent sharp decline in volatility prior to expiration with clearly defined – and acceptable – risk parameters.
Take for example Intra-Cellular Therapies (NASDAQ:ITCI). As you can see in Figure 1 this is clearly a stock that can “move,” having made an endless string of huge percentage price moves over the years.Figure 1: Courtesy ProfitSource by HUBBIn recent months ITCI has almost doubled in price AND implied volatility is now over 300% for 30-60-day options.Figure 2: Courtesy OptionsAnalysis.comSo, let’s consider one example of a way to potentially take advantage of this spike in volatility. The strategy is referred to as a “Modidor,” which is sort of slang for a “modified condor”. Figure 3 displays the options used and the relevant facts and figures.Figure 3: Courtesy OptionsAnalysis.comFigure 4: Courtesy OptionsAnalysis.com
h3 Things To Note/h3
Get The News You Want
*The stock is presently trading at $12.84 a share
*The breakeven price at expiration is $6.20 a share
*There are 31 days left until expiration
*If ITCI is at any price above $6.20 at expiration the trade will show a profit
*The maximum profit of $280 will result if ITCI is between the two short strikes ($9 and $20) at expiration
*Above $21 a share, the profit at expiration is capped at $180
*The worst-case loss of -$220 will result if ITCI is below $4 a share at expiration
h3 In A Nutshell/h3*This position is a bet on ITCI doing something besides collapsing -51.7% (from $12.84 to $6.20) or more in the next 31 days. Under any other scenario the trade stands to make money.
*The trade has a relatively high “potential reward to potential risk” ratio
*The experience the worst-case loss would require a -69% decline in the price of the stock in the next 31 days (which it should be pointed out is a possibility for a stock like ITCI).
On the face of it this trade sounds like a decent bet. But just remember that ITCI is extremely volatile and HAS moved for than 50% in a month before. So, anything can happen.
As always, the trade presented here is NOT a “recommendation”, only as an example of one way to play an extremely high volatility situation.
Trading in financial instruments and/or cryptocurrencies involves high risks including the risk of losing some, or all, of your investment amount, and may not be suitable for all investors. Prices of cryptocurrencies are extremely volatile and may be affected by external factors such as financial, regulatory or political events. Trading on margin increases the financial risks.
Before deciding to trade in financial instrument or cryptocurrencies you should be fully informed of the risks and costs associated with trading the financial markets, carefully consider your investment objectives, level of experience, and risk appetite, and seek professional advice where needed.
Fusion Media would like to remind you that the data contained in this website is not necessarily real-time nor accurate. The data and prices on the website are not necessarily provided by any market or exchange, but may be provided by market makers, and so prices may not be accurate and may differ from the actual price at any given market, meaning prices are indicative and not appropriate for trading purposes. Fusion Media and any provider of the data contained in this website will not accept liability for any loss or damage as a result of your trading, or your reliance on the information contained within this website.
It is prohibited to use, store, reproduce, display, modify, transmit or distribute the data contained in this website without the explicit prior written permission of Fusion Media and/or the data provider. All intellectual property rights are reserved by the providers and/or the exchange providing the data contained in this website.
Fusion Media may be compensated by the advertisers that appear on the website, based on your interaction with the advertisements or advertisers.