To say that Allergan Plc Ordinary Shares (NYSE:AGN) has had a bad second half of the summer is an understatement. Coming into this earnings report, and since its last earnings report in July, the stock had fallen 30%. On this morning’s earnings report the stock dropped about 2% after the open before rebounding.
I am a strong believer in the fact that the short-term reaction to earnings is more gambling than investing. We never know what traders will do, regardless of the quality of the numbers.
At these levels, something had to give for AGN stock. It has been lagging the sector. Year-to-date the iShares NASDAQ Biotechnology Index (ETF) (NASDAQ:IBB) is up 19% while AGN down 17%, so it has some catching up to do.
Wall Street experts expected a lot of it and set the benchmarks high. As of yesterday, it was trading 27% below the average price target and a whopping 35% below the high. It was even trading 10% below the lowest of analyst expectations.
Usually when the price targets are this wrong, the experts reset their expectations. That usually comes in the form of bearish headlines. Luckily, most analysts already are holding pat on the stock. So since they have not been overzealous with their action ratings, the odds of a deluge of downgrades are low.
Technically, $160/$180 zone has been pivotal since 2013 when it served as a launching pad for a massive rally. Now it should provide some support. Often what was resistance because forward support. The worry there is that the loss of $190 per share could have triggered a large head and shoulder-like bearish pattern which would target $140 per share. This is not a forecast but I do have to recognize it exists.
Today, I am not risking $175 to buy the shares outright. Instead, I am using the options to set my risk much lower to create a moat around my trade. I like knowing that I am leaving room for error just in case price moves against my thesis.
Click to Enlarge Even though I can’t measure value from a price-to-earnings perspective, I know that there is perceived value from a price action view. Perception is a powerful thing and in this case, AGN stock sells at less than one price-to-book value. So it won’t be a massive disaster if I have to own the shares for a while at a discount.
This is important to the method of choice. I sell downside risk against a level where I am okay owning shares. Else I’d use spreads instead.
AGN Stock Trade Idea
The Trade: Sell the AGN Jun 2018 $130 put, which is a bullish trade for which I collect $2.85. Here I have an 85% theoretical chance of success. But if the price falls below my strike, I will accrue losses below $127.15.
Selling naked puts carries big risk. For those who want to mitigate it, they can sell a spread instead.
The Alternate Trade: Sell the AGN Jun 2018 $135/$130 credit put spread where I have about the same odds of winning. If so, the spread would yield 10% on risk.
Neither trade would require a rally to profit. In fact, Allergan stock could fall another 20% from here and I can still retain maximum gains.
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.
