COVID Testing Could Deliver a 216% Gain to Investors
A bull call spread in Quest Diagnostics Incorporated (NYSE: DGX) using the October $120 call option which can be bought for about $2.50 and the October $125 call could be sold for about $1.30. This trade would cost $1.20 to open, or $120 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 $120. The maximum gain is $380 per contract. That is a potential gain of about 216% based on the amount risked in the trade.
Now, let’s look at the details:
This is a trade based on the global pandemic, as The Street reported,
“Quest Diagnostics (NYSE: DGX) [recently] started selling a covid-19 test online to make testing directly accessible to people who have coronavirus-like symptoms or were exposed to someone with the disease.
This test has emergency-use authorization from the Food and Drug Administration.
People can purchase the coronavirus-test kits online and send them to Quest for assessment via FedEx or drop them at Walmart drive-through pharmacies, the Secaucus, N.J., diagnostic-testing-services company said.
Online orders will be reviewed by physicians in Quest’s network.
The U.S. is the country hardest-hit by covid-19, with more than 6.6 million confirmed cases and 196,842 deaths. according to data from Johns Hopkins.
“Accessible, high-quality covid-19 diagnostic testing is essential to containing the spread” of the disease, Jay Wohlgemuth, a physician who is senior vice president and chief medical officer at Quest Diagnostics, said in a statement.
QuestDirect has had a covid-19 antibody test available online since April.
The test kit includes a device for nasal-swab collection, which Quest said was comparatively less non-invasive.
Quest Diagnostics says on its website that its average turnaround time for covid test results is two days. It now has capacity to do as many as 200,000 tests a day.
In August the company had cut its turnaround time from an average of two to three days. In July the average was seven days.
Its capacity for testing results in August was 150,000 a day.”
The stock appears to have been bouncing off of support that has developed since the market’s initial rebound.
The longer-term chart using weekly data shows that DGX has reached new multiyear highs in the bull market that began in March. This could be due to investor expectations that the company’s business would benefit from testing related to the pandemic.
This news could be the catalyst for the news that traders have been pricing in over recent weeks. However, the broad market is risky and spread trades which limit risk could be a suitable strategy in this market environment.
A Specific Trade for DGX
For DGX, the October 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 October $120 call option can be bought for about $2.50 and the October $125 call could be sold for about $1.30. This trade would cost $1.20 to open, or $120 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 $120.
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 DGX, the maximum gain is $380 ($125- $120= $5; 5- $1.20 = $3.80). This represents $380 per contract since each contract covers 100 shares.
Most brokers will require minimum trading capital equal to the risk on the trade, or $120 to open this trade.
That is a potential gain of about 216% 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 DGX 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 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.