An Earnings Report Creates a Trading Opportunity
Ligand Pharmaceuticals Incorporated (Nasdaq: LGND) recently reported first quarter 2019 adjusted earnings of $1.16 per share, down from the year-ago figure of $1.55.
According to Zacks, “adjusted earnings exclude the impact of one-time tax gain of $640 million related to sales of Promacta rights. Including this gain, the company reported earnings of $31.32 per share. The Zacks Consensus Estimate was $28.42.
In March, Ligand sold all rights to Promacta, including royalty rights to worldwide net sales, to privately-held Royalty Pharma for $827 million”
Shares of Ligand were down on the news.
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Business Wire noted, “Total revenues for the first quarter of 2019 were $43.5 million, compared with $56.2 million for the same period in 2018.
Royalties were $19.5 million, compared with $20.8 million for the same period in 2018 and primarily consisted of royalties from Promacta, Kyprolis and EVOMELA.
Royalties reflect Ligand’s sale of Promacta to Royalty Pharma as of March 6, 2019, resulting in a partial quarter of Promacta royalties, and Ligand will not receive Promacta royalties going forward. Material sales were $9.0 million, compared with $4.4 million for the same period in 2018 due to the timing of Captisol purchases for use in clinical trials and commercial products.
License fees, milestones and other revenues were $15.0 million, compared with $30.9 million for the same period in 2018, with the prior-year quarter including an upfront milestone payment upon the out-license of Ligand’s Glucagon Receptor Antagonist program to Roivant Sciences.”
Looking ahead, “Ligand is affirming existing revenue guidance for 2019 with total revenues expected to be approximately $118 million including royalties of approximately $48 million, material sales of approximately $27 million and license fees and milestones of approximately $43 million.
Ligand is also affirming its existing adjusted earnings per share guidance of approximately $3.20, which excludes the impact of the gain recognized on the sale of Promacta of $30.09 per share compared to the initial estimate of the impact of the gain of $29.05 per share.
This quarterly report represents an earnings surprise of -95.92%. A quarter ago, it was expected that this drugmaker would post earnings of $1.27 per share when it actually produced earnings of $1.70, delivering a surprise of 33.86%.”
The stock has been in an extended down trend.
A Trading Strategy To Benefit From Weakness
A price decline often results in higher than average options premiums. That means option buyers will be forced to pay higher than average prices for trades, But, sellers could benefit from the higher premiums.
In this case, with a bearish outlook for the short term, a call option should be sold. The call should decline in value if the stock declines and sellers of calls benefit from this decline.
Selling options can involve a great deal of risk. A spread options strategy can be used to limit the potential risk of the trade.
One strategy that traders can consider is the bear call spread. This is a trade that uses two calls with the same expiration date but different exercise prices.
Traders buy one call and sell another call. The exercise price of the call you sell will be below the exercise price of the long call. The call is sold to limit the risk of the trade. So, this strategy will always generate a credit when it is opened and will always have limited risk.
The risk profile of this trading strategy is summarized in the diagram below which shows the limited risk and reward.
Source: The Options Industry Council
While risks and rewards are limited, this strategy will allow traders to generate potential gains in a stock they might otherwise find too risky to trade. Many individuals ignore bearish strategies because of the risks.
You’ll know the maximum potential gain with this strategy as soon as it’s opened. It is equal to the amount of premium received when the trade is opened. The maximum loss is equal to the difference between the exercise price of the options contracts less the premium received and is also known.
Every day, we scan the markets looking for trades that carry low risk and high potential rewards. These trades are available almost every day and we share them with you as we find them. Now, it’s important to remember these are trading opportunities in volatile stocks.
When we find a potential opportunity, we evaluate it with real market data. But because the trades are volatile, the opportunities may differ by the time you read this. To help you evaluate the current opportunity, we show our math and explain the strategy.
A Bear Call Spread in LGND
For LGND, we could sell a May 17 $115 call for about $4.45 and buy a May 17 $120 call for about $1.80. This trade generates a credit of $2.65, which is the difference in the amount of premium for the call that is sold and the call.
Remember that each contract covers 100 shares, opening this position results in immediate income of $265. The credit received when the trade is opened, $265 in this case, is also the maximum potential profit on the trade.
The maximum risk on the trade is about $235. The risk can be found by subtracting the difference in the strike prices ($500 or $5.00 times 100 since each contract covers 100 shares) and then subtracting the premium received ($265).
This trade offers a potential return of about 112% of the amount risked for a holding period that is relatively brief. This is a significant return on the amount of money at risk. This trade delivers the maximum gain if LGND is below $115 when the options expire, a likely event given the stock’s trend.
Call spreads can be used to generate high returns on small amounts of capital several times a year, offering larger percentage gains for small investors willing to accept the risks of this strategy. Those risks, in dollar terms, are relatively small, about $235 for this trade in LGND.