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High Income From Bad News in a Drug Trial

High Income From Bad News in a Drug Trial

Trade summary: A bear call spread in Blueprint Medicines Corporation (Nasdaq: BPMC) using May 15 $55 call options for about $6.20 and buy a May 15 $60 call for about $3.40. This trade generates a credit of $2.80, which is the difference in the amount of premium for the call that is sold and the call.

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  • In this trade, the maximum risk is about $220. 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 ($280). This trade offers a potential return of about 27% of the amount risked.

    Now, let’s look at the details.

    BPMC had been conducting a Phase 3 VOYAGER clinical trial of avapritinib versus regorafenib in patients with locally advanced unresectable or metastatic gastrointestinal stromal tumor (GIST).

    PR Newswire reported that “the VOYAGER trial did not meet the primary endpoint of an improvement in progression-free survival (PFS) for avapritinib versus regorafenib. Top-line safety data for avapritinib were consistent with those previously reported.”

    Traders seemed to react to that and pushed the stock price down.

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  • BPMC daily chartThere were additional details in the press release, “The VOYAGER trial evaluated the efficacy and safety of avapritinib (N=240) versus regorafenib (N=236) in patients with third- or fourth-line GIST.

    Avapritinib showed a median PFS of 4.2 months compared to 5.6 months for regorafenib. The difference in median PFS between the avapritinib and regorafenib groups was not statistically significant. The overall response rate was 17 percent for the avapritinib group and 7 percent for the regorafenib group.

    Avapritinib was generally well-tolerated with most adverse events reported as Grade 1 or 2. Top-line safety results were consistent with previously reported data, and no new safety signals were observed.

    Additional analyses of the VOYAGER trial results are ongoing, and Blueprint Medicines plans to present the data at a future medical meeting.”

    Based upon the news, the company, “expect that its existing cash, cash equivalents and investments together with anticipated product revenues but excluding any additional potential option fees, milestone payments or other payments under its collaboration or license agreements, will be sufficient to enable it to fund its operating expenses and capital expenditure requirements into the second half of 2022.

    Anticipated savings from the discontinuation of further development of avapritinib in non-PDGFRA exon 18 mutant GIST indications is expected to offset any previously forecast revenues from those indications through 2022.”

    This news is generally considered bearish and the stock could take out the recent lows.

    BPMC weekly chart

    Shorting shares of the stock exposes traders to significant risks in dollar terms. A spread trade with options allows traders to obtain exposure to the stock with a defined level of risk. That strategy is explained in detail below, at the end of this article.

    A Specific Trade for BPMC

    For BPMC, we could sell a May 15 $55 call for about $6.20 and buy a May 15 $60 call for about $3.40. This trade generates a credit of $2.80, 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 $280. The credit received when the trade is opened, $280 in this case, is also the maximum potential profit on the trade.

    The maximum risk on the trade is about $220. 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 ($280).

    This trade offers a potential return of about 27% 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 BPMC is below $55 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 $220 for this trade in BPMC.

    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.

    bear call spread

    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.

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