A Coronavirus Vaccine Could Create an 85% Short Term Gain
Trade summary: A bull call spread in Moderna, Inc. (Nasdaq: MRNA) using the April 17 $27 call option which can be bought for about $5.10 and the April 17 $31 call could be sold for about $3.70. This trade would cost $1.40 to open, or $140 since each contract covers 100 shares of stock.
In this trade, the maximum loss would be equal to the amount spent to open the trade, or $140. The maximum gain is $260 per contract. That is a potential gain of about 85% based on the amount risked in the trade.
Now, let’s look at the details.
In a Barron’s article. It was reported that, “The biotech firm Moderna said Monday that the first patient had been dosed with its vaccine against the novel coronavirus in the Phase 1 study being conducted by the National Institutes of Health.
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“This study is the first step in the clinical development of an mRNA vaccine against SARS-CoV-2, and we expect it to provide important information about safety and immunogenicity,” Moderna’s chief medical officer, Tal Zaks, said.
Moderna has drawn significant attention for its experimental vaccine, based on messenger RNA technology and developed in collaboration with the National Institute of Allergy and Infectious Disease. The stock surged in late February on excitement about the Covid-19 vaccine program, though company executives have said that Moderna is not focused on the vaccine’s commercial potential.
The dosing of the first patient in the Phase 1 study comes 63 days after Chinese authorities publicized the genetic sequence of the virus. The study is being run by the National Institutes of Health, and will include 45 healthy adults given two doses of the vaccine over 28 days.
In its statement on Monday, Moderna said it was preparing for a Phase 2 trial of the vaccine that it will conduct itself, and that it had already begun preparing doses for that trial. It said the Phase 2 trial could “begin in a few months,” and that it was preparing to accelerate its own manufacturing capacity so it could produce “millions of doses” if the vaccine is safe and effective.
Moderna is one of a growing number of companies developing Covid-19 vaccines, and one of three companies using mRNA technology to build a COVID-19 vaccine. Also on Monday, the German biotech BioNTech (BNTX) said it would begin testing its own experimental vaccine late next month.”
MRNA has neem volatile as traders followed news and rumors related to the development of the vaccine. The initial advance failed and prices pulled back to important support from where this latest rally began.
MRNA has been volatile throughout its short trading history. More volatility cannot be ruled out.
The risks of the stock and of the vaccine make this an ideal candidate for a risk limiting spread trade.
A Specific Trade for MRNA
For MRNA, the April 17 options allow a trader to gain exposure to the stock. This trade will be open for about six weeks and allows for traders to turn over capital quickly, potentially compounding gains several times a year.
An April 17 $27 call option can be bought for about $5.10 and the April 17 $31 call could be sold for about $3.70. This trade would cost $1.40 to open, or $140 since each contract covers 100 shares of stock.
The amount paid to enter the trade is the largest possible loss on the trade. This is generally true whenever a trader is creating a debit to enter an options trade. “Creating a debit” means there is a cost to enter the trade. You could create a debit by simply buying puts or calls to open a directional trade.
In this trade, the maximum loss would be equal to the amount spent to open the trade, or $140.
The maximum gain on the trade is equal to the difference in exercise prices less the amount of the premium paid to open the trade.
For this trade in MRNA the maximum gain is $2.60 ($31- $27= $4; $4 – $1.40 = $2.60). This represents $260 per contract since each contract covers 100 shares.
Most brokers will require minimum trading capital equal to the risk on the trade, or $140 to open this trade.
That is a potential gain of about 85% based on the amount risked in the trade. The trade could be closed early if the maximum gain is realized before the options expire.
A Trade for Short Term Bulls
As with the ownership of any stock, buying MRNA could require a significant amount of capital and exposes the investor to standard risks of owning a stock.
To reduce the risks of a trade, an investor could purchase a call option. This allows them to benefit from upside moves in the stock while limiting risk to the amount paid for the options. However, buying a call option can also require a significant amount of capital and includes the risk of a 100% loss.
Whenever an option is bought, the maximum risk is always equal to 100% of the amount of spent to purchase the option. Since options cost significantly less than a stock, the risk in dollar terms will usually be relatively small to own an option.
To further limit the risks of the trade, an investor could use a bull call spread. This strategy consists of buying one call option and selling another at a higher strike price to help pay for the cost of buying the first call. The spread strategy always reduces the risk of an options trade.
This strategy is designed to profit from a gain in the underlying stock’s price but has the benefit of avoiding the large up-front capital outlay and downside risk of outright stock ownership. The potential risks and rewards of this strategy are summarized in the chart below.
Source: The Options Industry Council
Both the potential profit and loss for the bull call spread are limited. The maximum loss is equal to the net premium paid when the trade is opened. The maximum profit is limited to the difference between the strike prices, less the debit paid to put on the position.
This strategy could be especially appealing with high priced stocks where the share price and options premiums are often a significant commitment of capital for smaller investors.