A COVID Vaccine Trade With Risk of Less Than $175
Trade summary: A bull call spread in Moderna, Inc. (Nasdaq: MRNA) using the August $80 call option which can be bought for about $10.15 and the August $85 call could be sold for about $8.44. This trade would cost $1.71 to open, or $171 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 $171. The maximum gain is $329 per contract. That is a potential gain of about 92% based on the amount risked in the trade.
Now, let’s look at the details.
MRNA has been working on a COVID-19 vaccine and as Yahoo Finance reported, the company’s “experimental coronavirus vaccine — … showed the treatment was not only effective, but produced a significant amount of COVID-19 antibodies —[and] boosted markets and stoked hopes of a vaccine by the end of this year, as the pandemic continues its spread.”
The report continued, “The Phase 1 clinical trial data, published [recently] in the New England Journal of Medicine, confirmed the company’s statements of positive results.
It’s still unclear if the vaccine, which requires two shots within a month’s time— is able to block the virus entirely. But if successful, Moderna’s candidate would be the first product the company gets to market, as well as the first vaccine using its proprietary mRNA technology.
And company officials on Wednesday voiced optimism about some level of dampening the effects of the virus, especially as new diagnoses soar worldwide — and continues unchecked in the United States.
The final phase of the trials, set to begin July 27, will better inform on the vaccine’s effectiveness.
CEO Stephane Bancel told analysts on a call Wednesday that discussions have only just begun of how the vaccine is likely to be distributed. Via Operation Warp Speed, U.S. officials have set an ambitious timeline to begin production on a candidate this year.
While no specifics were given, Bancel said the federal government would be in charge. “We see partnering with government as very important…it’s not up to private company to make that decision,” he added.”
MRNA is a speculative trade since the stock has limited history, trading since early 2019. Speculation about a vaccine has pushed the stock out of a trading range that defined the first year of trading.
The stock’s price is now dependent on news related to the virus vaccine. While MRNA has been making progress, drug trials tend to be high risk and the stock could fall sharply if bad news is released. Risk management is imperative in stocks like this. A spread trade offers significant potential and limited risk.
A Specific Trade for MRNA
For MRNA, the August 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 August $80 call option can be bought for about $10.15 and the August $85 call could be sold for about $8.44. This trade would cost $1.71 to open, or $171 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 $171.
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 $329 ($85- $80= $5; 5- $1.71 = $3.29). This represents $329 per contract since each contract covers 100 shares.
Most brokers will require minimum trading capital equal to the risk on the trade, or $171 to open this trade.
That is a potential gain of about 92% 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 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.