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Avoid Pharma Options — Except for This One

Lilly is the only star in the sector worth buying a call on


Pharmaceuticals aren’t looking so hot right now.

I have several on my sell list, including Immunomedics (NASDAQ:IMMU), Bristol-Myers Squibb (NYSE:BMY), Biogen Idec (NASDAQ:BIIB) and AstraZeneca (NASDAQ:AZN). Stay far away, and don’t try to trade puts on them, either. Based on my Power Options system (in which “normal” volatility is rated 35), these stocks are all rated in the low teens and 20s.

Even Coventry Health (NYSE:CVH), a formerly strong pharmaceutical that was recently purchased by Aetna, is beginning to plateau after a dramatic rise. It’s still strong, but I believe it’s reached resistance at around $43.

Merck (NYSE:MRK) and Novo Nordisk (NASDAQ:NVO) have both enjoyed upside trends, but they’re quiet for now — I’m not seeing much upside action in the near-term there.

However, there is one outlier in the group: Eli Lilly (NYSE:LLY), a major pharmaceutical that has been in a steady uptrend over the past year and has had a very strong past couple months. While a pullback from this recent rally wouldn’t be a surprise, as long as it doesn’t morph into a larger sell-off, this position should be safe. Lilly is scheduled to report earnings on Oct. 23.

Recommendation: Buy Lilly Jan 52.5 Call options at $1.05 or lower (when the stock is around $50.60). After entry, take profits if the stock price hits $52.60. At this point, the option should be around $1.90, giving you at least an 80% return. Exit if the stock closes below $49.60. The price of the calls would be about 70 cents at that point.

According to my Power Options system, the probability of hitting our profit goal is 17%.

That might seem low, but 20% is about average for low-cost options such as these. Plus, we calculate the probability that the option will hit its target price, but the probability of returning a smaller profit is higher.

Also, our computers calculate probabilities assuming a random market. That means there’s a 50% chance that stocks will rise over the next three weeks, and a 50% chance that stocks will fall. The listed number is the average probability.

So, a call option with a 20% probability theoretically has a 40% probability in a bull market, and a zero percent chance in a bear market. The opposite is true for a put option. It has twice the probability of reaching its target price in a bear market, and a zero percent chance in a bull market.

Ken Trester is editor of the popular Maximum Options program. Trester has been trading options since the first exchanges opened in 1973 with a winning streak that goes back to 1984 with money-doubling average annual profits since 1990.

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