Let’s just get this out of the way: Trading a stock as volatile as Valeant Pharmaceuticals Intl Inc (NYSE:VRX) is a gamble, not an investment. I consider setups as short-term trades based on price action, not on the fundamentals of VRX stock.
VRX stock is down 40% in 12 months, but it’s almost flat this year. Recently, Valeant had a 20% correction in as many days, which makes for a scary knife to catch. Sure, this would be an easy task if it were a value company like, say, Apple Inc. (NASDAQ:AAPL). But Valeant stock is a machete with a two-inch handle.
I won’t even try to defend Valeant’s business. Experts on both sides of the argument make legitimate points. Some say VRX is a fraud. Yet, others believe it’s a legitimate pharma stock. Either way, there’s a lot of smoke, so I must assume that there is a fire of some magnitude inside this stock. So I only dare trade it with options where I can build some margin for error.
Click to Enlarge VRX had a nice rally late June, but, unfortunately for the bulls, it gave the entire measured move back. It fell 20% back to the neckline where it sits now. So clearly, VRX stock has strong resistance over $17.
So I look below for areas of support, but I have little faith in anything above $12 per share. So in today’s setups I have to make room for the possibility that it could fall another 20%.
I reiterate that my setup today is a bet against price action, not value. I see that VRX price-book is under 2 but I am not sure I can trust it as an indicator of value. So tight stops are in order here.
The Bet: And yes, I do mean “bet.” Sell VRX stock Jan 2018 $10 naked put and collect 50 cents to open. Here I have an 80% theoretical chance that price will stay above my strike so I can profit maximum gains. Otherwise, I have to buy the shares and be open to losses below $9.50.
Selling naked puts into any equity is risky enough. Doing it in one as volatile as Valeant stock is aggressive. Those who want to mitigate some of the risk they can do so by selling a spread instead. There the maximum loss is limited by the width of the spread.
The Moderate Bet: Sell VRX stock Jan 2018 $10/$9 credit put spread where the odds of success are similar, but with much less money at risk. Yet the spread could still deliver roughly 15% in yield. Compare this to buying VRX shares at face value then hoping they rally for profit. We are entering into a historically difficult season for stocks especially ones that are considered frothy.
Both of these setups are bullish bets on VRX with a 30% buffer from current price, so I can still profit even if the stock falls. This is much different than buying the shares for $14.40 then hoping it rallies.
Although I said today that trading VRX stock is gambling, consider it a calculated risk. I’ve done it several times before and here is one example that delivered easy profits. That said, investing in the stock market doesn’t come with guaranteed results, so I never risk more than I can afford to lose.
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.