For the past 12 months Gilead Sciences, Inc. (NASDAQ:GILD) could have served as the poster-child for a falling knife to avoid. Many tried to catch it and lost a few fingers doing it. Calling a bottom in the stock was a fool’s errand… Until now.
Finally, GILD stock was able to participate in the biotech sector bounce that happened in June. As a result, the stock now has upside technical opportunities and the terminal points of one can lead to the starting point of the other. But there are tough zones to crack along the way.
When a stock falls for this long without a major change in its company fundamentals it creates value. So fundamentally, GILD is cheap relative to its industry. Its price-earnings ratio is one-fourth that of Pfizer Inc. (NYSE:PFE), almost a third of Bristol-Myers Squibb Co’s (NYSE:BMY) and one-sixth that of GlaxoSmithKline plc (ADR) (NYSE:GSK)
Technically, GILD has been a serial disappointer for the past two years. GILD stock peaked mid-June of 2015 and has since set lower highs that ended in a 50% drop in 24 months. Recently it finally had a 10% rally thereby breaking this vicious cycle of lower highs.
While this is a good start it’s not the end point. Gilead stock has a lot of hard work ahead. Time is important since equity markets in general are near all-time-highs and that in itself presents another facet of risk.
Click to Enlarge A falling stock doesn’t mean that I can’t trade it. Using options, I was able to profit from GILD trades.
Case in point is that in July of 2016 I set a trade to expire January and it delivered $1.65 in pure profit.
At the time I opened the trade, I specifically picked my level of risk below a long-term inflection point and it worked.
Today, I want to repeat performance. Like last time, I will also sell risk below a sizable buffer just in case the GILD stock sellers revert to their selling ways.
And also like last time, I am prepared to own the shares at lower levels should the trade sour on me. I cannot be certain that Gilead actually flipped from being a falling machete to shooting star, but I am willing to sell risk for income below support.
The Trade: Sell the GILD Feb $55 put to open the risk and collect $1. This trade has a 90% theoretical chance of success; and more importantly, it builds another 20% buffer to guard against potential rough patches in the next six months. But if price falls below my strike, I will have to own the shares. Then I could suffer losses below $54 per share.
Selling naked puts is dangerous and it is not for every investor … but I can accomplish the same goal by selling spreads instead. This renders the risk finite.
The Alternate Trade: Sell the GILD Feb $57.50/$55 credit put spread where I have a slightly smaller chance of success … but with limited risk, I can still yield roughly 20%. Compare this with buying the shares outright without room for error.
Investing is risky so there are no guarantees. So I never expose myself to scenarios that could potentially break me.
Learn how to generate income from options here. 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.
