Gilead Sciences, Inc. (NASDAQ:GILD) reported earnings on Tuesday, and it is getting punished in early trading. The initial reaction was a 7% selloff in GILD stock.
While I typically don’t like to catch falling knives, in this case, I will make an exception. Gilead Sciences has had a tough 2016, off nearly 20%, and it’s down more than 25% over the past 12 months.
Click to Enlarge However, Gilead is a fundamentally sound company with legitimate income streams. Technically, GILD stock is battling a 30-month-old pivot point. It’s trying to establish this as a base from which it can mount another rally.
Even though I like GILD stock for the long-term, I am not one to risk $82 per share. Instead, I will use the options markets, where I can structure hundreds of trades to set me long Gilead Sciences with little at risk.
2 Trades on GILD Stock
Trade No. 1: Sell the GILD Jan $65 put for $1.65 per contract. Ideally, I need Gilead to stay above $65 per share through mid-December. Selling naked puts is risky, so only do it if you’re willing and able to own GILD stock at your sold strike. Breakeven is $63.35 per share. If successful, this would represent a 2% yield relative to the stock price.
If GILD falls another 21% from current levels before my trade expiration, the stock may be put to me. That means I will be forced to buy Gilead at $65 per share, even if the actual price is lower. But If I’m successful, I would have generated income out of thin air.
Worst-case scenario is getting assigned GILD stock at my stock price, only for shares to keep falling from there. But in that case, I’d still be better off than if I had bought shares at $82.
Alternate trade: Selling naked puts is risky, and therefore requires margin. I can mitigate the risk to suit a smaller account by changing the trade to a credit put spread. Instead of selling naked puts, sell the Jan GILD $65/$60 credit put spread for 55 cents per contract. Ideally, I need GILD stock to stay above $65 per share to be successful. The difference to the first trade is that here my maximum loss is limited to the width of the spread less the money I collect to open the trade. If successful, my potential yield on money risked is a respectable 11%.
A credit put spread is usually easier to manage than selling naked puts. I have more conviction when my risk is hedged. I still need to manage the theoretical percentage chance of success, but at least I know the maximum damage should the worst-case scenario unfolds.
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.