This Generic Drug Maker Is Set Up for a Possible 184% Gain
Trade summary: A bull call spread in Dr. Reddy’s Laboratories Limited (NYSE: RDY) using the October $75 call option which can be bought for about $2.60 and the October $80 call could be sold for about $1.30. This trade would cost $1.30 to open, or $130 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 $130. The maximum gain is $370 per contract. That is a potential gain of about 184% based on the amount risked in the trade.
Now, let’s look at the details.
The company announced on Business Wire “the launch of over-the-counter (OTC) Olopatadine Hydrochloride Ophthalmic Solution USP, 0.2% and 0.1%, the store-brand equivalents of Pataday® Once Daily Relief and Pataday® Twice Daily Relief, in the U.S. market, as approved by the U.S. Food and Drug Administration (USFDA).
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Dr. Reddy’s Olopatadine Hydrochloride Ophthalmic Solution USP, 0.2% and 0.1% are indicated for the temporary relief of itchy eyes due to pollen, ragweed, grass, animal hair and dander. The Olopatadine Hydrochloride Ophthalmic Solution USP, 0.1% is also indicated for the temporary relief of red eyes.
“This launch marks the entry of Dr. Reddy’s into the OTC eye care space, and is a testament to our deep capabilities in bringing store-brand equivalents of Rx-to-OTC switches to the U.S. market,” says Marc Kikuchi, CEO, North America Generics, Dr. Reddy’s Laboratories.
“We are very excited to extend our strategic collaboration with Gland Pharma to bring these products to the market. We thank the teams at Gland and Dr. Reddy’s whose hard work and efforts have enabled the execution of this launch in such a short timeframe.”
The Pataday® brand had U.S. sales of approximately $31 million since the launch in March 2020.”
Traders seemed to respond to the news by pushing the stock up.
Dr. Reddy’s Laboratories Limited is a pharmaceutical company whose Global Generics segment includes manufacturing and marketing prescription and over-the-counter finished pharmaceutical products ready for consumption by the patient, marketed under a brand name (branded formulations) or as generic finished dosages with therapeutic equivalence to branded formulations (generics).
The company’s PSAI segment includes the Company’s business of manufacturing and marketing active pharmaceutical ingredients and intermediates (API) or bulk drugs.
Its Proprietary Products segment focuses on the research, development and manufacture of differentiated formulations and new chemical entities. These products fall within the dermatology and neurology therapeutic areas, and are marketed and sold through its subsidiary, Promius Pharma, LLC.
The stock seems to have broken resistance and could be headed substantially higher.
A Specific Trade for RDY
For RDY, 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 $75 call option can be bought for about $2.60 and the October $80 call could be sold for about $1.30. This trade would cost $1.30 to open, or $130 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 $130.
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 RDY, the maximum gain is $370 ($80- $75= $5; 5- $1.30 = $3.70). This represents $370 per contract since each contract covers 100 shares.
Most brokers will require minimum trading capital equal to the risk on the trade, or $130 to open this trade.
That is a potential gain of about 184% 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 RDY 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.