Yet another sector falls victim to the almighty Amazon.com, Inc. (NASDAQ:AMZN). Recently we’ve seen rekindled headlines of it entering the prescription drug sales arena. This caused tremendous selling in stocks like CVS Health Corp (NYSE:CVS) and Walgreens Boots Alliance Inc (NASDAQ:WBA).
Those two have been on my watchlist for a while, but I haven’t traded them because of the looming headlines over the takeover of Rite Aid Corporation (NYSE:RAD).
Now that it’s out of the way, I’m interested in betting on their price action.
I am not in denial of the potential damage that AMZN can inflict on a sector. I’ve seen the results in stocks like Macy’s Inc (NYSE:M). But I bet that investors have already priced in a lot of the potential damage.
On paper, CVS and WBA are almost identical. But today, I chose to trade the first because it has had better price action of late. In the past 12 months, CVS lagged, but year-to-date it is down 6% versus the other, which is down 14%. More importantly, the company held up better relative to its own support levels. And therein lies my interest.
To profit, I need proven support levels against which to sell risk. And if I choose carefully, time passes and prices hold above my risk so I can retain maximum gains. I cannot do this without knowing that there is value in CVS stock.
Fundamentally, it is not overpriced. It’s trading with a price-to-earnings ratio under 15 and a price-to-book ratio just over two. So it’s not likely that it would be a major mistake to temporarily own shares. I’m confident that I will be able to manage out of them in case the price goes against my trade through 2017.
Bottom Line on CVS Stock
Today’s trade is bullish; however, I will not buy shares and hope they rally. Instead, I will use CVS options where I can control my potential entry price. In other words I want to build a buffer between the current price and my trade.
Expectations on Wall Street are also bullish CVS stock. It is now trading 15% below the average price target. In fact, CVS stock is trading below the lowest of the analyst range. I don’t usually put too much emphasis on what the ‘experts’ say because they tend to be late, but it does show expectations are in line with my thinking.
The bet: Sell CVS Jan $60 put and collect 60 cents per contract to open. This is a bullish trade that has a 90% theoretical chance of success. But if the price falls below my strike, then I accrue losses below $59.40.
Those who want to mitigate the risk that comes with selling naked puts can sell a spread instead. There the maximum loss is much smaller.
The alternate bet: Sell CVS Jan $65/$60 credit put spread, where I have slightly smaller odds of winning. If so, the spread would deliver 10% in yield.
Just remember, investing in the stock market doesn’t come with guarantees, so I never bet more than I am willing 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 as @racernic on twitter and stocktwits.
