Last night, Celgene Corporation (NASDAQ:CELG) released a headline that they canceled phase three for their potential solution to Crohn’s disease. The stock is now trading down 10%. This means that it would now be down 16% since early October.
While this sounds like a disaster for recent bulls on the stock, luckily CELG came into this headline up 35% in 12 months. So even after this dip, the stock is still up over 20%. This would put it in line with the iShares NASDAQ Biotechnology Index (ETF) (NASDAQ:IBB)
So those who have been long the stock for a while are still set. For the rest, it too early to catch this falling knife?
No, but I have to use options. There is no telling what the stock will do in the short term. Corrections this big usually are not one-day events. But in options, I can structure trades where I can leave room for more downside. This reduces the need to be surgical with my timing.
However this doesn’t mean that I can blindly take trades.
CELG is expensive from a price-to-earnings ratio. Its P/E of 38 is well above that of AbbVie Inc (NYSE:ABBV) or Bristol-Myers Squibb Co (NYSE:BMY), which are both near 23. Price to book value is a whopping 16. Compare that to, say, Apple Inc. (NASDAQ:AAPL) which has a P/E less than half of CELG and a price to book of 6.5.
Click to Enlarge Technically and even before this dip, CELG stock was precariously perched and in danger of losing an ascending trend line. This headline caused its breach and will likely fill almost all of its measured move lower. The area around $125 per share has been in contention since January of 2015. So it is likely to present some support.
Should this CELG level also fail, then I look 15% lower for another similar zone of contention.
So to maximize my chances of success, my trade will have a large enough moat around it to account for the worst-case scenario given today’s news and metrics. Key to my strategy is that I am willing to own the shares at a discount should price go against my thesis.
On the heels of this news, there is the danger of some analysts downgrading the stock. It all depends who had the Crohn’s drug as part of their forward estimates. So this accentuates the need for my buffer today.
Currently Wall Street experts have a price range for CELG between $120 and $180 per share, so clearly according to them there is plenty of potential. Still I don’t chase any potential. All I need to win is that the stock stabilizes and stays above my support zones.
CELG Stock Trade Idea
The Trade: Sell CELG Jan $100 put and collect $1.20. Here I have an 80% theoretical chance of success. But if the price falls below my strike, then I own the shares and would suffer losses below $98.80.
Selling naked puts carries big risk, especially for a three-digit stock. For those who want to mitigate it, they can sell a spread instead.
The Alternate Trade: Sell the CELG $105/$100 credit put spread, where I have about the same odds of success. If so, then the spread would yield 15% on risk.
Ultimately, regardless of how careful I am, investing in stocks is fraught with danger, so I never risk more than I am willing to lose
Get my newsletter for free 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.