Juno Therapeutics Inc (NASDAQ:JUNO) is up an astonishing 50% this morning on the headline that it’s in talks for a buyout from Celgene Corporation (NASDAQ:CELG). Rarely do we see a move of this size, but it’s apt that it is happening in the biotech sector, which is notorious for big headlines.
Usually, I have no issues with rallies, especially rallies that are justified. In this case, I think that Wall Street is being a bit overzealous with its expectations. Even before this spike, JUNO stock was already expensive relative to the sector, so this giant spike would only make things worse from that perspective.
Analysts who are experts on the stock agree with me. At $70, JUNO is now trading 7% above the highest of their price targets and 25% above their average. This leaves the stock vulnerable to dips on the slightest hint that the deal with CELG is in danger.
How to Trade JUNO Stock
Today, I want to short JUNO stock because I believe it’s gone too far too fast. But before you send out for my arrest, know that I am only shorting the short-term price action. I have no issues with the company’s prospects. Besides, I realize that the analysts may raise their price targets higher, so I have to hedge my bearish risk.
To do that, I will finance my bearish bet by taking a bullish position in CELG. I will use options to set both trades. Buying a put spread in JUNO options is much safer than outright shorting the stock; if I short a stock outright, my potential losses would be unlimited.
The biotech sector is still under the threat of Trumpian headlines. President Trump has continued his sporadic negative rhetoric that has caused havoc in their stock prices.
You can see this in the recent price action in the iShares NASDAQ Biotechnology Index (ETF) (NASDAQ:IBB). This is another reason to use options where I can limit losses. I consider this pair trade as a speculative bet in a conservative portfolio.
The bottom line is that a 50% pop on speculation is as good a reason to short JUNO as any. I hedge my bet by taking a risk on another quality stock like CELG. This is my way of doing some arbitrage with no money out of pocket.
The Bearish Bet on JUNO: Buy JUNO May $65/$62.50 debit put spread for 75-cents-per-contract. This is my maximum potential loss, but if JUNO falls through my spread, I stand to triple my money.
To hedge my bet, I will sell downside risk into the prospective buyer CELG.
The Bank – Bullish Bet on CELG: Sell the CELG Mar $90 put for $1-per-contract. Here, I have an 80% chance that I would retain maximum gains.
Taking both trades results in a net credit. So as long as the CELG price stays above my put, I am a winner already. Any premium that I recover by closing the JUNO put spread would be pure incremental profit.
Ultimately, 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.