Name That Trade – $AMGN: Bio Fuel

by Dan October 28, 2015 11:33 am • Commentary

Event: Amgen (AMGN) reports Q3 results tonight after the close. The options market is implying about a 4% one day move tomorrow, which is rich the 4qtr average of about 2.75%.  

Sentiment: Wall Street analysts are fairly mixed on the stock with 12 Buy ratings, 10 Holds and zero Sells with an average 12 month price target of $185, about 14% higher than current levels.

Price Action / Technicals: After spending the better part of 2015 consolidating between $150 and the low $170s, the stock broke out to new all time highs on July 31st following Q2 results, and proceeded to drop nearly 30% into the end of September:

[caption id="attachment_58039" align="aligncenter" width="600"]AMGN 1yr chart from Bloomberg AMGN 1yr chart from Bloomberg[/caption]

The stock’s recent bounce from $130 to current levels places it very near the midpoint of the prior range, and now up close to 2% on the year.

Taking a slightly longer term view, the five year charts shows the stock’s steady ascent, with the only break of the uptrend coming late last month:

[caption id="attachment_58040" align="aligncenter" width="600"]AMGN 5yr chart from Bloomberg AMGN 5yr chart from Bloomberg[/caption]

Implied Volatility Snapshot:  30 day at the money implied vol (blue line) appears elevated at 30%, but the charts above clearly show how the volatility bands have been dramatically widened of late, with 30 day realized volatility (how much the stock is actually moving) at 36%, making options prices look at the very least fair:

[caption id="attachment_58041" align="aligncenter" width="600"]AMGN 1yr chart of 30 day at the money IV (blue) vs realized vol (white) from Bloomberg AMGN 1yr chart of 30 day at the money IV (blue) vs realized vol (white) from Bloomberg[/caption]

My Take:  AMGN is a fairly reasonably priced biotech stock, trading at 15x expected eps growth of 10% in 2016 with a pretty stellar balance sheet ($30 billion in cash, $31 billion in debt, with a $123 billion market cap).  While AMGN has not shied away from large acquisitions (ONYX for $10.4 billion in 2013), the company has also been a rumored target.  Maybe the next phase of biotech m&a is mega caps consolidating, who knows?  But in the meantime, the mood has clearly changed towards the prior one way nature of the sector, and volatility seems to be here to stay.

What’s the Trade?

AMGN has rallied nearly 25% from late September into tonight’s earnings, possibly discounting some good news. With so much uncertainty in the sector those that are long the stock or thinking of buying are likely better served by defining risk to the upside. Here’s a defined risk options trade that we prefer to long stock here:

Hypothetical Stock Alternative – AMGN ($161) Buy Dec 160/180/200 call butterfly for $5.25

-Buy 1 Dec 160 call for 7.30

-Sell 2 Dec 180 calls at 1.05

-Buy 1 Dec 200 call for .05

Break-Evens on Dec Expiration:

Profits: between 165.25 and 194.75 of up to 14.75, with max gain of 14.75 at 180

Losses: of up to 5.25 between 160 and 165.25 and between 194.75 and 200, with max loss of 5.25 below 160 and above 200

Rationale – This trade structure defines potential losses to 5.25 but offers profit potential of up to 14.75 if the stock is back near its highs towards year end. Considering the run from (really) recent lows of 130, it makes sense to define risk into the event for those that want to be long.