Here’s How to Trade After a Stock Gains 300% In a Day
Many investors wish they owned Amarin (Nasdaq: AMRN) last week. They’d have benefited from the stock’s 313% gain on Monday.
This is a drug company and the rise is due to test results. Analysts noted,
“The recent results come from Amarin’s clinical trial of Vascepa. This is a supplement from the company that is used to treat patients that are at risk of experiencing major adverse CV events. The study included 8,179 patients and has been going on since 2011.”
The results from the study saw Vascepa meeting its primary endpoints. This had provided a relative risk reduction of 25% when compared to those on a placebo. This is a major statistical significance (p<0.001) for the supplement.
The good news for Amarin stock continues with multiple secondary endpoints from the study also confirming the primary endpoint. Another benefit is that there was no major difference between adverse events from the treatment when compared to patients on the placebo.
“We are delighted with these topline study results,” John F. Thero, President and CEO of Amarin, said in a statement.
“Given Vascepa is affordably priced, orally administered and has a favorable safety profile, REDUCE-IT results could lead to a new paradigm in treatment to further reduce the significant cardiovascular risk that remains in millions of patients with LDL-C controlled by statin therapy, as studied in REDUCE-IT.”
Amarin stock is also likely getting a boost from plans to expand the sale of Vascepa following the successful study results.
The company is looking to increase the number of sales representatives it has in the U.S. It is also looking to work with regulators outside of the U.S. to bring the supplement to other countries.”
Well, the big move happened but that doesn’t mean that traders should ignore the stock. The long term chart below uses monthly data to show that there is still significant potential in the stock.
AMRN traded even higher in 2011. And the rally then looks similar to what we see now. But, at that time, hope got ahead of the company’s ability to deliver. This time the company could be set to meet elevated expectations.
However, that collapse shows that there is risk. The best trade could be one that strictly limits risk since volatility is likely in this stock for the foreseeable future.
A Trade for Short Term Bulls
As with the ownership of any stock, buying AMRN 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.
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 AMRN
For AMRN, the October 19 options allow a trader to gain exposure to the stock.
An October 19 $15 call option can be bought for about $0.89 and the October 19 $19 call could be sold for about $0.28. This trade would cost $0.61 to open, or $61 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 $61.
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 AMRN the maximum gain is $3.39 ($19 – $15 = $4.00; $4.00 – $0.61 = $3.39). This represents $339 per contract since each contract covers 100 shares.
Most brokers will require minimum trading capital equal to the risk on the trade, or $61 to open this trade.
That is a potential gain of about 420% 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.