Valeant Pharmaceuticals Intl Inc (NYSE:VRX) is not a long-term bet, by any means. The company is struggling with elevated debt levels, business restructuring and a severe image problem due to high drug prices. The mix just doesn’t bode well for the long run.
But there was a short-term development this week that could have VRX stock skipping higher heading into next month’s quarterly earnings report.
It’s a development that holds promise for Valeant options traders.
Click to EnlargeSpecifically, VRX stock broke above its 50-day moving average for the first time in two months yesterday. The momentum has even carried it north of its key weekly trendlines as well, including the 52-week moving average.
This latter trendline capped Valeant stock back in June and July. With these technical hurdles now below the shares, the stock has a relatively clear path higher from a technical perspective.
Furthermore, there is plenty of sideline cash that could be brought to bear on VRX stock over the short-term. Sentiment remains highly bearish on Valeant, and while there is good reason for this, the potential for short-term shifts that could boost the stock is high.
For instance, Thomson/First Call reports that only two of the 20 analysts following VRX stock rate the shares a “buy.” That’s quite a bit of room for upgrades.
Additionally, as of the most recent reporting period, some 12.6% of Valeant’s float was sold short. Short sellers will be the most vulnerable to a short-term spike in VRX stock, and a rally might prompt a squeeze play that could exacerbate the problem.
As for VRX’s options backdrop, short sellers appear quite unprepared for a short-term jump in VRX stock price. Currently, the October put/call open interest ratio rests at a bearish reading of 1.04, with puts outnumbering calls among front-month options.
Since shorts typically buy calls as a hedge against rallies in the underlying stock, VRX shorts don’t appear to be taking a short-term rally seriously.
Turning to October implieds, options traders are pricing in a potential move of about 7.5% for VRX stock. This places the upper bound at about $15.60, with the lower bound arriving at roughly $13.40.
Two Trades for VRX Stock
Call Spread: With Valeant looking to breakout, from a technical perspective, a short-term bull call spread could be the best way to take advantage of this strength. Remember, we are looking short-term due to the uncertainty and high debt load that could affect Valeant’s Nov. 4 earnings report.
As such, traders looking to bet on a near-term rally for VRX stock might want to consider an Oct $15/$15.50 bull call spread. At last check, this spread was offered at 17 cents, or $17 per pair of contracts. Breakeven rests at $15.17, while a maximum profit of 33 cents, or $33 per pair of contracts — a potential 94% return — is possible if VRX stock closes at or above $15.50 when October options expire.
Put Sell: Alternately, if you’re not buying into VRX stock’s recent bull run, then an Oct $13 put sell has a good chance of finishing out of the money. At last check, this put was bid at 15 cents, or $15 per contract. As usual with a put sell, you keep the premium as long as VRX stock closes above $13, when October options expire. On the downside, if VRX trades below $13 prior to expiration, you could be assigned 100 shares for each put sold at a cost of $13 per share.
As of this writing, Joseph Hargett did not hold a position in any of the aforementioned securities.
