This Upgrade Could Be the Start of Good Things for This Stock
News often seems to trend. Good news is followed by additional good news, for example, while bad news tends to be followed by additional pieces of negative news. This might seem to be the case in real life for many individuals. It also applies to the stock market.
In the stock market, the cycle can be relatively easy to understand.
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We might see a piece of news that seems to be good. It might be the release of a new product or approval from a regulator. That leads to analyst upgrades in many cases. Then sales start, and sales allow for financing of new products. It really can become a virtuous cycle, so to speak.
The Cycle Could Be Starting for ACADIA
Recently, a drug company received good news from regulators and then analysts upgraded the company.
The Food and Drug Administration assigned ACADIA Pharmaceuticals Inc. (Nasda: ACAD)’s Nuplazid a positive safety profile. That sent the stock price up. But, that up trend could just be starting, at least according to Piper Jaffray whose analysts often release reports quickly after news.
Brill said she expected the FDA’s conclusion, but considered the announcement notable.
“Now that the FDA has publicly supported Nuplazid’s safety and efficacy profile for PDP, we expect Rx growth to accelerate at a much faster pace than the small signals we’ve seen over the past several weeks,” she noted.
Noting a “restored growth trajectory,” Brill said she anticipates a guidance beat with 2018 sales of $235 million.
Piper Jaffray raised its peak Nuplazid sales estimates from $600 million to $750 million and said the stock reflects only the renewed Parkinson’s disease psychosis opportunity and not the prospects for major depressive disorder.
“Now that the safety overhang is officially cleared, we think risk-reward ahead of MDD data in Q4 is too compelling to stay on the sidelines,” Brill said, noting low downside risk for the stock and more than 30-percent upside risk.
Following a Phase 3 trial in dementia-related psychosis, Acadia could cash in on another $1-billion opportunity, the analyst said. The adjunct schizophrenia trial could contribute additional upside, although Piper Jaffray has low expectations, she said.
This news could be the catalyst for a new up trend in the stock.
A Trade for Short Term Bulls
As with the ownership of any stock, buying ACAD 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 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 ACAD
For ACAD, the October 19 options allow a trader to gain exposure to the stock.
An October 19 $22 call option can be bought for about $1.17 and the October 19 $24 call could be sold for about $1.02. This trade would cost $0.15 to open, or $15 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 in ACAD, or $15.
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 ACAD the maximum gain is $1.85 ($24 – $22 = $2.00; $2.00 – $0.15 = $1.85). This represents $185 per contract since each contract covers 100 shares.
Most brokers will require minimum trading capital equal to the risk on the trade, or $15 to open this trade.
That is a potential gain of more than 1,000% 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.