Investment Overlay Update – $CBST – Amending Options Overlay on Expiry

by Enis December 20, 2013 12:16 pm • Commentary

We overwrote our CBST long stock position in our Investment Portfolio about a month ago by selling the Dec 65 call at 3.80. That call can now be closed at 1.60 with the stock 2.00 higher from where we overwrote the position.  We will be adjusting the position though, rather than simply closing it.

The price action over the last month in CBST leads us to believe that the stock will have a hard time breaching the $70 level in the coming months.  The main news catalysts have come and gone, and both were met with immediate selling on the pops.  With that in mind, we like the idea of overwriting our stock position in the interim, with a view towards potentially adding leverage to the upside if the stock does make it down to the high 50’s.  

Dec expiry has arrived today, and we’re going to roll our long stock / short call position out to January, and collect the incremental yield.

ACTION – Roll the CBST ($66.50) short Dec 65 call out to the Jan 65 call (buy to close Dec 65 call, sell to open Jan 65 call), collect an incremental $1.75.

The average price of the stock at this point is now $58.04 (61.84 purchase price, with additional 3.80 from Dec call), with the new sale of the Jan call potentially adding an incremental 2.8% in yield (on a monthly basis, that’s more than 30% per annum).


Investment Overlay – $CBST – It’s Probably Just a Phase 3, November 21, 2013:

CBST was our inaugural investment idea for RiskReversal, executed at the start of November.  The full post details our thoughts on the company and the stock.  We concluded with:

As we’ll do with all our longer term investment trades we’ll look to manage this position using options as we know more about the timing of trials and other events in the company’s future.

CBST has rallied up to near its all-time highs over the past few weeks.  Implied volatility is priced quite high as traders anticipate the release of CBST’s phase 3 data of Ceftolozane/tazobactam for Complicated intra-abdominal infections (cIAI) and complicated urinary tract infections (cUTI) 2H 2013.  Here’s the volatility chart for CBST:

CBST 30 day implied vol (red) vs. 30 day realized vol (blue), Courtesy of LiveVolPro
CBST 30 day implied vol (red) vs. 30 day realized vol (blue), Courtesy of LiveVolPro

Market participants expect a good bit of volatility due to the Phase 3 trial data, so implied volatility (red) is near the highs of the year even though realized volatility (blue) is quite subdued recently.

We do not know what the outcome of the event will be, but we want to collect some of this highly priced premium against our existing long stock position in CBST. So here’s an overwrite:


INVESTMENT OVERLAY:  Against Long 100 shares of CBST (currently 64.75, purchased for 61.84) stock, sell 1 CBST Dec 65 Call at 3.80


Trade Rationale:  If CBST closes above 65 on Dec expiration, then our long stock position will get called away (though we can adjust the trade in the future if we want to keep our stock position).  However, if CBST closes below 65, we will have collected the extra premium and would remain long stock, thereby reducing our cost base on our long stock position overall.