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A Settlement Could Clear This Stock for Further Gains

A Settlement Could Clear This Stock for Further Gains

Often, we find that there can be a great company that appears to be under-performing in the stock market. It’s the job of Wall Street analysts to discover why that under-performance exists. They might do this by scouring regulatory filings and talking to management and customers.

It may require significant time and effort but the reason many stocks are under-performing can often be discovered by an analyst with the ability to reach management for a discussion. In this way, Wall street analysts provide a valuable service.

As individual investors, we may not have time to complete that level of research. As individual investors we may not be able to even see the research of these analysts since not all Wall Street research is publicly available.

But, there are times when the reason for under-performance is cleared and the stock price jumps. Then news stories will indicate what the possible problem was and allow individual investors to find trades that could deliver gains in the short run.

News Pushes This Stock Higher

In a recent news story, TheStreet reported,

Shares of Edward Lifesciences Corp. (NYSE: EW) surged nearly 8% […] after the company agreed to pay rival Boston Scientific Corp. (BSX) $180 million to settle long-standing patent disputes over heart valve replacement devices.

EW daily chart

“All pending cases or appeals in courts and patent offices between the two companies will be dismissed, and the parties will not litigate patent disputes related to current portfolios of transcatheter aortic valves, certain mitral valve repair devices, and left atrial appendage closure devices.

Any injunctions currently in place will be lifted,” the companies said in a statement.

Boston Scientific and Edwards Lifesciences have been embroiled in a number of legal cases over the years involving heart valve replacement systems, including transcatheter aortic valves, in the U.S. and Europe.

The valves are used in a relatively new procedure called transcatheter aortic valve replacement, or TAVR, in which the original heart valve is not surgically removed.

Boston Scientific produces medical technology and devices for patients. Edwards Lifesciences, based in Irvine, Calif., is the global leader in patient-focused medical innovations for structural heart disease, as well as critical care and surgical monitoring.

Shares of EW have been in a trading range for most of the past year and the resolution of this matter could have a bullish impact on the stock, especially if the stock market remains bullish in the short run.

EW weekly chart

A Trade for Short Term Bulls

As with the ownership of any stock, buying EW 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.

bull call spread

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.

A Specific Trade for EW

For EW, the February 15 options allow a trader to gain exposure to the stock.

A February 15 $170 call option can be bought for about $5.75 and the February 15 $175 call could be sold for about $4.30. This trade would cost $145 to open, or $145 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 $145.

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 EW the maximum gain is $3.55 ($175 – $170 = $5.00; $5.00 – $1.45 = $3.55). This represents $355 per contract since each contract covers 100 shares.

Most brokers will require minimum trading capital equal to the risk on the trade, or $145 to open this trade.

That is a potential gain of about 144% based on the amount risked in the trade. The trade could be closed early if the maximum gain is realized before the options expire.

In this trade, options provide income and defined risk. These are the type of strategies that are explained and used in TradingTips.com’s Extreme Profits Calendar service. This service uses seasonals as one indicator in its trade selection process. To learn more about how options can be used to meet your goals, click here for details on Extreme Profits Calendar.