Valeant Pharmaceuticals Intl Inc (NYSE:VRX) is not your typical stock. It’s a polarized name that has haters and avid fans alike. I fit in neither camp. I love the price action of VRX stock, and nothing else. Period.
I accept that the fundamentals are less than ideal. Among Valeant’s problems are legislative trouble and price model issues. There is also the looming high debt risk — it’s a highly leveraged company. These are all reasons not to own VRX stock in the long-term.
This week, Valeant stock tumbled on a poorly received earnings report and rough headlines. So to say this is an obvious time to catch this falling knife by buying VRX would be insane.
Luckily, I have the options markets.
Options allow me to structure a trade that would allow me to reload my previous winners. Last December, I wrote about how to trade VRX for free. The trade was an easy win.
The thesis again here will be that VRX fans will defend the stock within 25% of current levels.
The Bet: Sell the Oct $7.50/$5 credit put spread. This is a bullish trade for which I collect 30 cents per contract. The 44% buffer from current price gives this trade an 85% theoretical chance of success. If VRX stock stays above my sold strike, this trade would yield 12% on money risked.
Someone with more courage than me could modify this trade to yield a bigger profit but with much greater risk.
The Alternate: Sell a $7.50 put naked and collect 50 cents per contract. If price falls below it I would be put the stock. Anything below $7 per share would accrue losses for me.
Selling naked puts is dangerous, so I only do it if I am willing and able to own the stock at the strike sold.
I don’t trust VRX stock, nor do I trust these general markets at all-time highs. I think this rally could be perched on too tall of a tree. For these reasons, I will start by selling the spread, then decide if I want to turn it into a naked put sold.
I am not required to hold my positions through expiration. I can close any options trade for partial gains or losses at any time.
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.
