When horrible news gets less worse. Playing the Valeant bounce

In spite terrible news over the past year the news has gone from horrible to less worse and there is a glimmer of hope for this beat down drug company.

On Tuesday April 5th, Valeant Pharmaceuticals announced that a special board committee had completed an internal investigation without discovering additional financial fallout from the firms previous ties to a controversial pharmacy company (Philidor). Furthermore the company has set plans to meet a key April 29th filing deadline required to avoid potential default on debt obligations. (Since writing this, “less worse” news has revealed information that Perrigo’s Joseph Papa is finalizing deals to take over as CEO).

The trade idea came about on Thursday April 7, when Valeant won support to waive a default on their loan, as well as other eased restrictions. New update on position here.

At times, I lean more contrarian in my trading approach which is why this recent spurt of good news led me to initiate a trade in Valeant using options contracts and stock, symbol $VRX. In this blog I will outline my open and closed trades and how I have so far successfully played this potential reversal in the trend.

You probably know the famous Rothschild quote, “the time to buy is when there’s blood in the streets“. Looking at the 12 month chart of Valeant one can see that the blood has flooded the streets for this stock.

The blood starting spilling late in 2015 when industry experts started arguing whether or not Valeant is the next Enron and might go bankrupt and politicians, like Hillary Clinton created a flash crash in Valeant’s stock with promises to “go after” drug companies with high prices.

clintontweet

Shares of Valeant have dropped 744% since this Tweet was posted on Sep 21, 2015.

chartclintontweet

I really hate that companies like Valeant can price gouge drugs. It makes me sick to see patients selling their homes and taking on more debt to buy a medicine that should be more easily available to the average person. But just because I feel this way (just like many feel this way) does not mean Valeant is going bankrupt!  One thing I’ve learned is that the market does not have a moral compass. If it did, the market wouldn’t have rallied after the March 22 terrorist attack in Brussels (see chart below).

spy3.22a

I’m almost to my trades but wanted to share this last chart of $VRX dating back to year 2000. Notice the huge volume this year. Keep in mind, for every seller there is a buyer. I’m suspicious that large institutional buyers are gobbling up shares of Valeant at discount prices, just like Rothschild would have done in the 18th century. This is the contrarian in me. It’s also very hard to say for certain who is on the other end of this trade but I am taking a very small bet that the smart money is getting ready for a reversal in trend.

VRXweekly2000

Here are the trades. 

Trade 14(a): 4/5/16 -4/7/16 (closed)

  • Lightly bought to open the $VRX May 20th $30
  • Price Paid: $4.14
  • Avg Price Sold: $5.96
  • Avg. Percent Gain per contract: 30%
  • Highest Percent Gain: 88%

VRX

Trade 14(b): 4/5/16 -4/6/16 (closed)

  • Lightly bought shares of $VRX at $28.27
  • Sold half at $30.20
  • Percent gain: 7%

Trade 14(C) 4/6/2016: VRX (straddle)

  • Straddled remaining shares with May 20, 2016 35 put/call for $11.20
  • Sold to open May 20, 2016 $35 put
  • Put premium collected: $5.81
  • Sold to open May 20, 2016 $35 call.
  • Call premium collected: $5.31
  • Total premium collected: $11.12

If you’re new to options trading the trade is a little more complex.  I’ll try to break it down:

The put side of the trade:

They way this trade works on the put side is that I promise to buy 100 shares at $35 IF the stock is below $35 come May 20th expiration. Because I made the promise by selling the options I collected $5.81 per contract ($581 total). My cost basis on this promise is $35 minus the $5.81 premium I collected so my break-even is really $29.19. That is a 17% decline from today’s close!

The call side of the trade: 

The way this trade works on the call side is that I promise to sell 100 shares at $35 IF this stock is above $35 come May 20th expiration. Because I kept 100 shares which were bought at $28.27 I am promising to sell the stock at $6.73 profit per share. But because I also collected a premium of $5.31 for selling this contract my real profit per shares would be $12.04. That’s a 52% gain.

My break even:

If the stock is below $35 on May 20th and I keep the put that I sold I will have to buy the stock at $35 per share. With 200 shares my cost basis per share will be $31.63. That doesn’t include the total options premium I collected for selling my strangle. Including the total premium would drop my cost basis down to $20.5 (31.62-$11.12).

The question to seriously consider is if this stock could drop 41% from today’s close. This would mean the shares are at my break-even of $20.5 and I would seriously need to consider whether or not this is another good buying opportunity. It may or may not be, but one thing I know that will help me determine this is if the bad news has gotten worse!

Follow me on Twitter @ Jeffreytief

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