Valeant Pharmaceuticals Intl Inc (NYSE:VRX) has been nothing short of a casino trade for most traders. Luckily, we’ve used the options markets to sell risk, and that has mostly worked. Now, I want to sell mid-term risk on this massive drop in VRX stock to generate income.
Click to Enlarge This drop in Valeant stock today is an industry-wide move, in large part sparked by bad news from supplier McKesson Corporation (NYSE:MCK), which predicted a bad year amid increasing scrutiny of drug prices. The iShares Nasdaq Biotechnology Index (ETF) (NASDAQ:IBB) is dropping, led by biotechs such as Biogen Inc (NASDAQ:BIIB) and Gilead Sciences, Inc. (NASDAQ:GILD), both off more than 3%.
A major industry overhang fear stems from the potential Clinton win in the 2016 elections. She has vowed to battle their pricing models. Without pricing power, their valuations will need to reset in a major way. So the threat is real.
However, I believe that if Clinton wins and once she is in the White House, she will not continue her crusade. It will likely lose intensity and fade.
At worst, it will meld into another form of ambiguous policy with minimal consequences.
How to Trade VRX Stock Now
When selling risk, I like my trades to be boring. In credit spreads, boring is beautiful. Selling risk into the biotech sector, especially VRX stock, is the opposite of boring. But I need a little speculation in my portfolio, so here it goes:
The Trade: Sell VRX Dec $12.50/$10 credit put spread. This is a bullish trade for which I collect 21 cents per contract to open. If successful, this trade yields 9% on money risked with an 85% theoretical chance of success. Ideally, I need VRX stock to stay above my sold strike to win. This constitutes a 35% buffer from current price levels.
The Alternate Trade: Since Valeant reports before the expiration of the trade, I want to propose an alternate trade that has an even bigger buffer from current price.
Sell VRX Jan $10/$7.50 credit put spreads. This is a bullish trade for which I collect 24 cents per contract to open. If successful, this trade yields 10% on money risked with an 85% theoretical chance of success. This has a 50% buffer from current price levels.
Either trade would need a seriously bad headline to cause VRX to set new lows and get cut in half. This is the kind of speculative trading I like. One that needs an unforeseen disaster to foil my trade. The odds are literally in my favor in this calculated risk trade.
I am not obliged to hold the trade through its expiration. I can close it at any time 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.
