This Drug Company Might Be Back on Track
Valeant Pharmaceuticals (NYSE: VRX) has been rallying on good news this week. The company announced that Health Canada granted approval for SILIQ (brodalumab) injection for patients with moderate-to-severe plaque psoriasis.
SILIQ™ is indicated for the treatment of moderate-to-severe plaque psoriasis in adult patients who are candidates for systemic therapy or phototherapy. Valeant expects to begin sales and marketing of SILIQ™ in Canada in the second half of 2018.
This was the second piece of good news for the stock this week. The stock was also boosted by news of its $1.25 billion debt offering, maturing in 2026. The stock may be bottoming after a recent pullback.
Promising Signs for a Troubled Company
Plaque psoriasis is the most common type of psoriasis, a chronic, non-communicable, skin disease. The disease alters the life cycle of skin cells, causing them to build up rapidly on the surface of the skin.
In technical terms, SILIQ works by binding to IL-17Receptor A with high affinity, thereby blocking the inflammatory downstream activity of IL-17A, IL-17F, IL-17A/F heterodimer and IL-17E. By targeting the IL-17 receptor, SILIQ prevents skin cells from accumulating.
In three clinical studies that have been completed, between 51 and 67.5% of patients who used SILIQ achieved total skin clearance within a year.
The approval of SLIQ could help the company boost revenue. As Richard Lajoie, president of Valeant Canada, explained, “We believe SILIQ™ fulfills a significant unmet medical need with its potential to improve the quality of life for many patients across Canada who suffer from moderate-to-severe plaque psoriasis.”
He added, “Our team’s success in bringing to market this important treatment for people who live with this debilitating, incurable condition demonstrates our commitment to Valeant’s mission of improving people’s lives with our healthcare products.”
Dr. Charles W. Lynde, MD, FRCPC, Diplomate American Boards, Dermatology, Associate Professor in the Department of Medicine at University of Toronto, agreed, noting “An additional biologic has just received its approval.”
“SILIQ is the only biologic in the treatment of plaque psoriasis that has demonstrated a Psoriasis Area Severity Index (PASI) 100 as a primary endpoint. Our moderate-to-severe plaque type psoriasis patients will benefit from this new drug being now on the market.”
The drug is also approved in Europe and Japan.
Bulls were also buoyed by steps the company took to boost its balance sheet. Valeant has been trying to shrink the large debt load it took on following an acquisition spree under previous management.
The company recently issued $1.25 billion in unsecured senior notes due 2026. That money will be used to retire debt that was scheduled to mature in 2020 and 2021.
KDP Investment Advisor’s Mark McCabe writes that he viewed the move and the pricing as a positive for Valeant’s credit, as the offerings “extend the company’s maturities and are leverage neutral.” This view seems to be confirmed by derivatives traders.
Credit Default Swap spreads provide insight into investors’ perception of the credit quality of a company. IHS Markit’s CDS index track this indicator. The index compares the current 5-year CDS spread to its most recent one- and three-year ranges to measure relative credit sentiment.
Increases in CDS spreads often indicate credit concerns for a bond issuer. VRX’s spread is shown below.
Source: IHS Markit
Although VRX credit default swap spreads are rising, indicating some deterioration in the market’s perception of the company’s credit worthiness, they are among the lowest levels seen during the last one year.
This is all bullish, but not all analysts are bulls. Wells Fargo’s David Maris writes that the new debt is priced with a coupon around 9%, compared to 6% for the older debt. Valeant will likely keep refinancing debt at “higher and higher rates with longer and longer maturities until it can no longer do so.”
A Trade for Short Term Bulls
As with the ownership of any stock, buying VRX 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.
A Specific Trade for VRX
For VRX, the April 20 options allow a trader to gain exposure to the stock.
An April 20 $18 call option can be bought for about $0.50 and the April 20 $19 call could be sold for about $0.25. This trade would cost $0.25 to open, or $25 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 $25.
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 VRX the maximum gain is $0.50 ($19 – $18 = $1.00; $1.00 – $0.50 = $0.50). This represents $50 per contract since each contract covers 100 shares.
Most brokers will require minimum trading capital equal to the risk on the trade, or $25 to open this trade.
That is a potential gain of about 100% 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.