While the S&P 500 continues to rally to new highs for the year, biotech stocks continue to languish.
One of the biggest names in biotech, Amgen, Inc. (AMGN) continues to trade sideways in an ever narrowing range. I look for this period of consolidation to resolve itself shortly with a breakout in one direction.
As seen in the chart below, Amgen stock has been putting in a series of lower highs and also higher lows while chopping around the critical $145 level. The 20-day moving average of $145.59 also coincides at that level, providing further fuel once the inevitable breakout occurs.
Amgen has just scored a legal victory against rival drug makers Sanofi SA (ADR) (SNY) and Regeneron Pharmaceuticals Inc (REGN) involving a new cholesterol drug, although the companies stated they will appeal the ruling.
The market reaction to the decision was rather muted, however. Of course, the market reaction to AMGN generally has been rather muted over the past several weeks. The tighter AMGN continues to coil, however, the larger the likelihood that a breakout will occur.
The options market has certainly taken note of this sideways consolidation, with implied volatility (IV) at the lowest level since last December. This makes options prices comparatively less expensive, setting up a breakout trade by going long a straddle.
Quick Analysis of AMGN
Click to Enlarge I pulled down the option prices from yesterday and also from Feb. 12 to provide a good comparison on just how much cheaper the straddle pricing has gotten.
- On Feb. 12, AMGN stock closed at $144.72 and the March weekly $145 straddle with 28 days until expiration was trading right around $11 (33.25 implied volatility)
Click to Enlarge On March 17, AMGN stock closed at $144.13 and the April $145 straddle with 29 days until expiration was trading right around $8 (roughly 24 implied volatility)
To put it differently, on Feb. 12 you would need the stock to close 7.5% from the $145 strike price to break even ($11/$145) while on March 17 you would need only a 5.5% move from the $145 strike price to break even ($8/$145).
So to me, buying options at the cheapest level of the year to position for a breakout on a stock that is coiled very tightly makes good probabilistic sense. At the end of the day, trading is about probabilities, not certainties.
Amgen Trade Idea
Buy the AMGN April $145 calls and simultaneously buy the AMGN April $145 puts for a total net debit of about $8.
For this type of trade, I would use a time stop for my risk control since I am doubly long option premium. In two weeks’ time, I would revisit the position and trim out roughly half to limit the effect of time decay.
As of this writing, Tim Biggam did not hold a position in any of the aforementioned securities. Anyone interested in finding out more about option-based strategies or for a free trial of the Delta Desk Research Report can email Tim at tbiggam@deltaderivatives.com.
