A COVID Breakout Could Provide a 47% Gain
Trade summary: A bull call spread in Emergent BioSolutions Inc. (NYSE: EBS) using the June 17 $75 call option which can be bought for about $4.90 and the June 17 $80 call could be sold for about $2.88. This trade would cost $2.02 to open, or $202 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 $2.02. The maximum gain is $298 per contract. That is a potential gain of about 47% based on the amount risked in the trade.
Now, let’s look at the details.
GlobeNewswire reported that EBS announced an agreement to “deploy its contract development and manufacturing (CDMO) services to support the manufacturing of Johnson & Johnson’s lead vaccine candidate for COVID-19 that leverages the AdVac and PER.C6 technologies from the Janssen Pharmaceutical Companies of Johnson & Johnson.”
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Under the agreement, valued at approximately $135 million, Emergent will provide drug substance manufacturing services with its molecule-to-market CDMO offering, supported by investments from Johnson & Johnson beginning in 2020, and will reserve certain large-scale manufacturing capacity to pave the way for commercial manufacturing of Janssen’s adenovirus-based COVID-19 vaccine beginning in 2021.
To support Johnson & Johnson’s goal of supplying one billion doses of a COVID-19 vaccine, a long-term commercial manufacturing agreement is under negotiation for large-scale drug substance manufacturing anticipated to begin in 2021.
Large-scale manufacturing of drug substance for Johnson & Johnson’s vaccine candidate will be done at Emergent’s Baltimore Bayview facility, a Center for Innovation in Advanced Development and Manufacturing (CIADM) designed for rapid manufacturing of vaccines and treatments in large quantities during public health emergencies. Emergent’s CIADM is a result of a public-private partnership with the U.S. Department of Health and Human Services (HHS).
“Eight years ago, HHS invested in novel public-private partnerships to create three Centers for Innovation in Advanced Development and Manufacturing or CIADMs to help strengthen the nation’s biotech infrastructure to prepare and respond to emergencies,” said Gary Disbrow, Ph.D., acting director of the Biomedical Advanced Research and Development Authority.
“Leveraging the capacity available at the Bayview CIADM to speed development and manufacturing of COVID-19 vaccine is precisely how we envisioned these centers be used in pandemic response.”
Syed T. Husain, senior vice president and CDMO business unit head at Emergent, stated, “We share with our partners the same urgency to combat COVID-19 and will leverage our talents, capabilities, and capacities up to 300 million doses to advance this much-needed vaccine candidate and ensure ongoing commercial supply through our CDMO services.”
Emergent’s Bayview facility has unique capabilities across four independent suites to produce at clinical scale to get candidates rapidly into the clinic, while at the same time scaling up to enable large-scale manufacturing to up to 4000L to prepare for production of commercial volumes to meet customer demand. The CIADM has the capacity to produce tens to hundreds of millions of doses of vaccine on an annual basis, based upon the platform technology being used.
The breakout appears to be completing an extended pattern that provides a price target above $100 a share.
A Specific Trade for EBS
For EBS, the June 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.
A June 17 $75 call option can be bought for about $4.90 and the June 17 $80 call could be sold for about $2.88. This trade would cost $2.02 to open, or $202 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 $2.02.
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 EBS the maximum gain is $2.98 ($80- $75= $5; 5- $2.02 = $2.98). This represents $298 per contract since each contract covers 100 shares.
Most brokers will require minimum trading capital equal to the risk on the trade, or $202 to open this trade.
That is a potential gain of about 47% 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 EBS 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 EBS 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.