Coming into this earnings report, GW Pharmaceuticals PLC- ADR (NASDAQ:GWPH) stock has had a decent year, up 10%. Management delivered their quarterly results and investors love it, up 3.5%.
Fundamentally, I can’t argue for value. But since it sells at 5.7 times sales-to-book value, I am fairly confident I can own shares at a discount and manage out of them for a profit. Therein lies today’s thesis for my trade.
Usually I like to generate income by selling against value. But in this case, since I don’t have much of it, I will sell risk against price support levels. I will basically sell puts into what others fear and let time do the rest.
If time passes without price falling below my support, then I would have created income with zero out-of-pocket expense. However, the foundation of this trade set up is that I am willing to temporarily own the GWPH shares at a discount.
This is not a stock for the faint of heart. In the past year, it has had three directional move that were larger than 20% in magnitude. It’s a momentum stock and those are tricky to trade. They move so fast that they scare most investors out of trading them. That’s why I use options. There I can choose my risk levels thereby reducing the need to be surgical in my entry price.
I will use options to create a buffer zone to account for a potentially imperfect entry point. Regardless of how convicted I am with my thesis, I always leave room for error. So I won’t buy the stock outright and risk $123 per share on the hopes of a rally. When I sell puts below proven support levels I have a much higher change of success.
Technically and coming into its earnings, GWPH stock was trading at the upper end of its range. More recently — in the last five months — it had been setting higher lows and knocking on a neckline. Now the bulls have the opportunity to breach and target setting new highs above $150 per share.
GW Pharmaceuticals is part of a sector that is prone to headlines, so it often sees big directional moves. Furthermore, they are still under threat from politicians who seem dedicated to combat their pricing models. So far nothing has come of it, but the rhetoric is a negative catalyst to their stock prices.
Click to Enlarge Expectations for GWPH stock are high. Experts on Wall Street have a Strong buy bias on it with an average price target near $150 per share. If the stock doesn’t play catch up with their expectations they could downgrade it and that would be a threat to my trade. So I consider this a somewhat speculative trade in a conservative portfolio.
GWPH Stock Trade Idea
The Trade: Sell the Feb 2018 GWPH $105 put for $2.50 per contract. This is a bullish trade which has an 80% theoretical chance of success. But if the price breaches my support, then I accrues losses below $97.50.
Selling naked puts carries big risk, especially in a frothy stock like GWPH. For those who want to mitigate it, they can sell a spread instead.
The Alternate Trade: Sell the Feb 2018 GWPH $110/$105 credit put spread, which has about the same odds of winning but with smaller defined risk. Still if it wins, the spread will deliver 14% in yield.
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.