Treatment Excitement Could Reverse Fortunes For This Stock
Trade summary: A bull call spread in Gilead Sciences, Inc. (Nasdaq: GILD) using the April 17 $80 call option which can be bought for about $5.60 and the April 17 $85 call could be sold for about $4. This trade would cost $1.60 to open, or $160 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 $160. The maximum gain is $340 per contract. That is a potential gain of about 112% based on the amount risked in the trade.
Now, let’s look at the details.
In a recent MarketWatch article, companies developing treatments for coronavirus.
A mix of legacy drugmakers and small startups have stepped forward with plans to develop vaccines or treatments that target the infection caused by the novel coronavirus.
Gilead is best known for developing the first major cure for hepatitis-C, Sovaldi. This led to billions in sales and profits for the company.
The company also makes HIV drugs, including Truvada for pre-exposure prophylaxis (PrEP), its preventive HIV medicine, and remdesivir, a drug used for treatment.
Now, the company is working on a cure for coronavirus, testing the drug in the US with a randomized, controlled clinical trial in Wuhan and testing remdesivir as a treatment for mild to moderate forms of pneumonia in people with the virus.
The trial was given the go-ahead by China’s Food and Drug Administration in February.
The company offered information on progress of its US test:
- On Feb. 21, the National Institute of Allergy and Infectious Diseases started enrolling patients in a randomized, double-blind, placebo-controlled Phase 2 trialevaluating 394 hospitalized patients with COVID-19 at up to 50 sites worldwide, including at three sites in Singapore and South Korea.
- However, the majority of the study locations are in the US. The trial is expected to conclude April 1, 2023. Sites include the National Institutes of Health in Bethesda, Md., (not recruiting), the University of Nebraska Medical Center in Omaha (recruiting), the University of Texas Medical Branch in Galveston (not recruiting), and Providence Sacred Heart Medical Center in Spokane (recruiting).
- On March 3, Gilead said a randomized, open-label Phase 3 trial will evaluate remdesivir in 600 patients with moderate COVID-19. The trial start enrolling patients in March, with results to come in May. The clinical trial listing states the study is taking place in Hong Kong, Singapore, South Korea and the US. The company will also test other does of remdesivir.
The stock has displayed significant volatility in the market pullback.
That volatility could now be to the inside as stochastics, a popular momentum indicator, turned bullish.
A Specific Trade for GILD
For GILD, the April 17 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 April 17 $80 call option can be bought for about $5.60 and the April 17 $85 call could be sold for about $4. This trade would cost $1.60 to open, or $160 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 $160.
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 GILD the maximum gain is $3.40 ($85- $80= $5; $5 – $1.60 = $3.40). This represents $340 per contract since each contract covers 100 shares.
Most brokers will require minimum trading capital equal to the risk on the trade, or $160 to open this trade.
That is a potential gain of about 112% 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 GILD 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.
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.