Valeant Pharmaceuticals Intl Inc (NYSE:VRX) has been on a wild ride in 2016. I usually avoid selling premium in headline tickers like VRX. When selling premium, I want nothing to happen, thereby letting time kill the premium for my profit.
VRX stock is the opposite of nothing.
However, I occasionally brave some credit put spreads, and so far, I’ve been lucky trading Valeant shares.
My last trade in VRX is still in progress and slightly under pressure. I sold a bullishly skewed iron condor that I purposefully set with a smaller buffer than my normal requirement. The reward there is the potential high yield it can still deliver. Think of it as a speculative play in a conservative portfolio.
Today, I want to take a stab at a longer-dated trade with a bigger buffer from current price.
Click to Enlarge The fundamentals for VRX haven’t changed much. There are experts arguing either side of the fence, and both sound reasonable. The bulls make the case that Valeant Pharmaceuticals is a real business whose stock is temporarily hurt by headlines and therein-lies the stock price opportunity. Bears peg VRX as a sham business built on a house of cards.
I believe the truth lies somewhere in between. So I will literally sell risk against both extreme arguments. Given the seriousness of the headlines, I will use finite risk where I am totally accepting of the max loss should it occur.
2 Trades on VRX Stock
Trade #1: Sell the VRX Jan $12.50/$10 credit put spread for 22 cents per contract. If VRX stock stays above $12.5 per share this year, this trade can yield 9% on money risked. This trade has a 45% buffer from current price and a 85% theoretical chance of success.
I always like to reduce my exposure. in this case, I want to hedge by sell bearish premium in iShares Nasdaq Biotechnology Index (ETF) (NASDAQ:IBB). By selling the upside risk in an exchange-traded fund, I reduce my exposure to surprise mega-moves in Valeant stock on positive headlines. I cut my headline risk in half.
Trade #2: Sell the IBB Dec $320/$325 credit call spread to collect 75 cents per contract. To win, I need IBB to stay below $320 per share through expiration. If the 12% price buffer holds up my reward is 17% yield on money risked.
Click to Enlarge Taking both trades increases the potential yield and somewhat balances the trade against price action in either direction.
I have to be mindful of the election effect, however. As long as Hillary Clinton has the advantage, healthcare stocks like VRX will be under pressure. There could be surprising relief if she wins, though, since she won’t have a reason to keep them in the headlines. It will be months before she could actually start following up on her promises of waging the price-cap war against the industry.
I am not obliged to hold these positions through expiration. I can close either for partial gains or losses.
Nicolas Chahine is the managing director of SellSpreads.com. As of this writing, he did not hold a position in any of the aforementioned securities. You can follow him on Twitter at @racernic and StockTwits at @racernic.
