For the last few weeks, healthcare stocks have been hit hard. This is not from any fundamental fault of their own, but rather from political rhetoric. Both Republicans and Democrats alike want to punish them as we near another round of elections. But therein lies the opportunity.
The politicians can inflict harm on the stock price of Intuitive Surgical (NASDAQ:ISRG), for example, but eventually, the Profit and Loss statement will win over the fear mongering. After all this is a company that has been delivering phenomenal results for years and will continue to do so for more to come.
But for now, the stock price is falling, so I consider this trade tactical from the sense that I’d be catching a falling knife. Usually I don’t like to be the hero, but in this case, I am confident in Intuitive Surgical’s long-term prospects, so I don’t mind turning this trade into an investment.
Therefore, I can buy the shares outright here going into earnings. If they sell it off on Monday, then I would add to my stake once they hit the right levels to do that.
ISRG Stock by the Numbers
Fundamentally, Intuitive Surgical stock is not cheap. It sells at a 56 trailing price-to-earnings ratio and 16 times sales. But it is a growth stock, so for now I don’t worry too much about the margin. When the company matures and starts to stagnate, then I’ll judge it more on profitability.
The stock recently had a full correction (as Wall Street defines the term) as it fell more than 10% in mere days. Luckily, it did so from a fresh all-time high. In February, ISRG broke out into a bullish pattern, and true to its form, the stock filled the entire target. I’ve seen this happen in this stock many times before, so this is a chart that respects technical formations.
To that point, ISRG broke down from the very sharp rising wedge ahead of the earnings. This resulted in taking out a lot of recent froth from the recent rally. This was an inevitable scenario, but one that doesn’t change the bullish thesis. It is merely short-term price action where traders booked fast profits going into a binary event.
So in theory I can go long the shares ahead of tonight’s earnings report. But doing so would leave me vulnerable to a short term dip from the coin flip event. So it’s best to take the position in tranches — one today and the next I can add to it next week. This would leave me room to average my entry cost lower, so I can hold the stock with better conviction.
The options markets provide other ways to trade the stock. One is to limit the out-of-pocket expense and replace the stock purchase with that of June calls or call spreads. But unlike the stock, the risk there is that time becomes my enemy. To profit with calls, I would need the move to happen soon, else I risk losing money even if the stock doesn’t fall.
That is why I prefer to sell downside risk into what others fear. Wednesday, ISRG stock fell 6.5% so I could sell the April 26 $455 put to collect $2 per share. The money goes into my account now, and if ISRG stays above that level then I created income out of thin air. Otherwise, I would break even at $453 per share.
For a longer-term trade, I would sell the July $400 put, which would create the opportunity to profit $4 per contract while leaving me a 23% buffer from the current price. In return, I commit to buying shares at $400 if the price falls through that level between now and July. In that case, I don’t start losing money until $396 per share.
So this drop in ISRG stock does not change its long-term outlook. This is normal price action that is part of any breakout. The bulls have to retest the necklines from which they broke out to make sure they are solid enough to take the next leg higher.
After the recent correction ISRG lags the S&P 500 for 2019, but year-to-date it is still a super star stock. In the past 12 months, ISRG stock is up almost three times more than the S&P. Moreover, it corrected because of the negative sentiment against all healthcare stocks.
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.