While the iShares Nasdaq Biotechnology Index ETF (IBB) is up 19.8% this year Mylan N.V. (NASDAQ:MYL) stock was down 9% coming into its earnings. Even after this pop on earnings the stock trading 5% below the average price target on Wall Street.
Expectations do matter from a price action perspective. At first, the current level to price target discrepancy, while it sounds like a slam dunk upside opportunity, presents a risk. The longer it lingers this much lower than the expected range, the more likely they are to lower their targets. Those headlines would be detrimental to the stock price.
So this morning, after a better-than-expected profit, Mylan stock is up a little. So this clears the way to trade under normal headline risks. I don’t like to open trades just ahead of earnings reports because they tend to be binary events.
Click to Enlarge So today I want to place a bullish bet that the recent support levels will hold for the next few months. This means that I will sell downside risk against MYL stock. If I am right then I keep the premium I collect because the option will expire in my favor.
Fundamentally, MYL is not cheap with a 29 price to earnings ratio. This to 30% higher than that of Pfizer Inc. (NYSE:PFE). But it’s not bloated either, meaning this is not a case of gross overpricing. Still, today’s bet is more one on the price action within a volatile sector.
I still have to worry about President Donald Trump’s threat. He vowed to put the vise to the drug companies any which way that he can. For now it’s merely a headline and not yet a crusade. As soon as he closes a few other fronts, I expect more rhetoric on this front. So I have to build a sizeable buffer to account for that possibility.
Technically, MYL stock had a few bad days, falling more than 10%. It has now completely filled the gap up from early October. Usually markets don’t like to leave open gaps, and this one looked good to fill. This morning’s move is mild enough that so far it looks like it will be a non-event.
From the recent price action, I can assume that between $32.50 and$30 per share the stock should find buyers. But I want to rely on the monthly chart, which suggests that at $30 should find stronger MYL stock support. So I will extend my buffer below that.
MYL Stock Trade Idea
The Trade: Sell the MYL Apr 2018 $27.50 put for 60 cents. This is a bullish trade which does not require a rally to profit. Here I have an 85% theoretical chance of success. But I would accrue losses below $26.90.
Selling naked puts carries big risk especially for a biotech stock like MYL. For those who want to mitigate it, they can sell a spread instead.
The Alternate Trade: Sell the MYL Apr 2018 $27.50/$25 bull put spread which has about the same odds of winning and would yield 12% on risk. Compare this with risking $36 per share here and without any room for error expect a rally profit.
Today’s trade, although it would benefit from one, doesn’t need a rally to profit. I merely need MYL stock to hold its support for the next few months. I am betting that the value in the stock will prevent sellers from taking things too far. It is important know that if they do, then I want to own the shares at a discount from here.
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.