Valeant Pharmaceuticals Intl Inc (NYSE:VRX) is roughly a tenth of its former self, going by its 2015 highs. VRX stock fell from about $263 to just above $23 per share in roughly 12 months. Throughout the fall, Valeant shares have been a bear trap for traders, who keep getting lured in for a strong bounce. It has had many, but none have taken hold yet.
Click to Enlarge Technically, there is not much to decipher except that VRX stock recently established yet another short-term pivot level around $24 per share. High-profile money managers like Bill Ackman are betting that VRX will survive this ordeal. Others like Citron Research are betting that it’s headed to zero.
On the fundamental side, VRX recently received new hope from the FDA on potential new drugs from their pipeline, as well as the approval of a constipation drug from Progenics Pharmaceuticals, Inc. (NASDAQ:PGNX), which is licensed to Valeant. This could provide cash flow to relieve pressure off its balance sheet. Citron and other experts highlight the VRX debt burden that is likely to kill the company. A cash flow increase would provide funds to service the debt and fuel a recovery plan.
Going long VRX stock is a risky proposition and should only be done as a speculative play in a well-balanced portfolio. I would not buy Valeant shares in my proverbial nest egg. Luckily, the options market provides me with a cheap alternative to risking $24 per share to buy VRX stock.
2 Trades on VRX Stock
Trade No. 1: Buy the VRX Jan $25/$27.50 debit call spread for 95 cents per contract. This is my maximum potential loss. To be successful, I need Valeant stock to rally past both legs by mid-January. If so, I stand to essentially double my money.
Normally, I like to sell puts to finance this trade. However, in this case I would be leaving myself open to additional losses. If Citron is correct and VRX stock falls even further, then my sold puts would add to my losses. Selling a credit put spread would bring in some funds to potentially offset the call entry price in Trade No. 1 with limited additional risk.
Trade No. 2: Sell the VRX Jan $17.50/$15 credit put spread, also for 95 cents. This is my maximum potential profit. I need VRX stock to stay above $17.50 per share through mid January. Selling the credit put spread is risky, and I only do it if I believe that Valeant is not heading to zero. Else my max loss could be as high as $1.60 per contract on this trade alone.
Taking both trades reduces my out-of-pocket expense to a net debit of 5 cents. A base cost this low makes it easy to monetize the debit call spread in Trade No. 1, provided VRX stays above $17.50 per share.
Although the trades are set for January expiration, I am not obliged to hold either of them through their term. I can close either 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.
