Is There Still Time to Profit After a One Day Gain of More Than 70%?
Often, traders learn about big moves in stocks from the news. For example, last week, on Thursday, shares of Sage Therapeutics Inc. (Nasdaq: SAGE) jumped more than 73% after the company reported positive results in a midstage trial of a treatment for severe depression.
This drug potentially offers doctors a new mechanism to treat the disease.
This was a Phase 2 trial of the Sage-217 drug. There are three phases in the Food and Drug Administration approval process. This test involved 89 adult patients with moderate to severe major depressive disorder (MDD).
Traders immediately pushed the stock price up on the news.
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A Breakthrough Treatment Is Possible
Sage announced that the drug met its primary and secondary endpoints. Patients showed a statistically significant mean reduction in the Hamilton Rating Scale for Depression after just 14 days of treatment compared with the placebo. The drug was well-tolerated with no serious or adverse events according to the company.
The company noted that 64% of patients in the trial achieved remission by day 15, “which is a very important data point that’s often not cited as a selling point for standard-of-care medicines (such as SSRIs) because the bar is so high,” according to analysts familiar with testing protocols.
Most depression-drug trials run for four to six weeks, on the assumption that it takes that long for the drugs currently used to show an effect on the patient. For patients suffering from severe depressive symptoms, that waiting period can be hard to tolerate and if an initial prescribed drug doesn’t work, treatment can be delayed for months.
“It’s hard to understate how meaningful these data are in the backdrop of the very significant unmet medical need in depression: even if the SAGE data on a placebo-adjusted basis weren’t differentiated via cross-trial comparisons, we still think ‘217 would be an important drug as it offers a new mechanism (extra-synaptic GABA-modulation) in an area where the vast majority of options generally modulate the same pathways (serotonin, dopamine, norepinephrine),” said analysts with Leerink.
RBC analysts were bullish in the news, raising their stock price target to $280 and forecasting further gains, “and good likelihood of takeout at premium to current levels.”
Sage Chief Executive Jeff Jonas M.D. noted that there has been little innovation in depression treatments for the last two decades. Most depressive patients are still treated with selective serotonin reuptake inhibitors, or SSRI’s, the family that includes Prozac and zoloft.
This new drug, Sage-217, shares pharmacology properties with Sage’s other drug, brexanolone, a derivative of a compound found naturally in the brain that recently produced positive results as a treatment for post-partum depression.
That indicates the drug could be used in other treatments. “These very encouraging data suggest the potential of SAGE-217 in the treatment of MDD as well as other mood-related disorders that we may pursue,” according to Jonas.
Trading After the News
All of this news has pushed the price up and many traders will now be concerned about buying. The stock could pull back but history shows any pull back is likely to be relatively minor. This is based on history which shows that large gains are rarely reversed quickly.
The long term chart shows that SAGE is now extended, but the stock has moved slowly after large gains in the past.
From the perspective of an options trader, there is quite a bit of good news in a large price move. The stock has become more volatile. This is generally true whether the stock has moved up or down on the big move.
Higher volatility is generally associated with higher options prices. This is because options prices reflect a number of factors. The price of a call or put option is affected by the price of the underlying stock, the current level of interest rates, the time left to expiration and the volatility of the underlying stock among other factors.
Increased volatility, when it leads to increased options prices, sets up a number of potential trading opportunities for options traders. That indicates that after a large price move, a trader doesn’t need to be concerned with whether or not the price move will be reversed.
Instead of accepting a position that depends on a directional move and can carry a great deal of risk, an options trader can establish a position with a high likelihood of success and a defined level of risk.
A Strategy to Trade Sage Therapeutics
SAGE is likely to remain in a relatively narrow trading range while investors wait for news on how the steep discounts are affecting the company’s bottom line. This indicates a significant move in the stock price is unlikely.
When a stock is expected to remain in a narrow range for some time, it is possible to generate income from the stock. A number of options strategies could be used to meet this objective.
Among those strategies is a bull put spread that could be used. The risk and reward diagram is shown below and it offers limited risk with limited potential gains. However, it is well suited for a stock which recently saw increased volatility and is likely to remain in a narrow range.
Source: The Options Industry Council
This options trading strategies involves two put options. One put option is bought and a second put option with the same expiration date but with a lower exercise price is sold. Selling the put option will generate immediate income, just like the more familiar covered call strategy would. But, unlike a covered call, risk is limited.
Many traders will be familiar with the idea of a covered call. This is a conservative strategy many long term investors use to generate income in stocks they own that are unlikely to make large moves.
Although the bull put spread is different than a covered call, the bull put spread strategy meets the same objective as the covered call which is to generate some income. This trade generates immediate income and carries limited risk.
For Sage Therapeutics, a bull put spread could be opened with the January 19 put options. This trade can be opened by selling the January 19 $150 put option for about $6.40 and buying the January 19 $145 put for about $4.50.
This trade would result in a credit of $1.90, or $190 per contract since each contract covers 100 shares. That amount is also the maximum potential gain of the trade.
The maximum possible risk is the difference between the exercise prices of the two options less the premium received. For this trade, the difference between exercise prices is $1.00 ($150 – $145). This is multiplied by 100 since each contract covers 100 shares.
Subtracting the premium from that difference means, in dollar terms, the total risk on the trade is then $310 ($500 – $190).
The potential gain is about 61% of the amount of capital risked. This trade will be for about five weeks and the annualized rate of return provides a significant gain.
The bull put spread is an example of how options are a versatile tool and could meet many of your trading objectives. In this trade, options provide income and defined risk that could be lower than owning the stock. This strategy could also simplify tax reporting for investors.
These are the type of strategies that are explained and used in TradingTips.com’s Options Insider service. To learn more about how options can be used to meet your goals, click here for details on Options Insider.