Anatomy of a Trade – $AMGN Stock Alternative

by CC November 2, 2015 11:57 am • Education

Prior to Amgen’s (AMGN) Q3 earnings last week we detailed a stock alternative trade idea for existing longs or for those considering a new long in an effort to mitigate risk into a potentially volatile event. AMGN’s initial post earnings reaction was higher but it has since pulled back a bit and is basically where it was before the event. I wanted to take the opportunity to check in on the stock alternative idea and discuss trade management for the situation. To recap, here was the trade idea and our rationale for options in lieu of owning stock:

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

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.

With the stock at $161.75 this trade is essentially unchanged from before the event. Implied vol is lower but with two short 180 calls this trade is pretty close to vega neutral (it is +2 in vega, meaning changes in implied vol don’t have a large effect on the overall price of the trade.) It’s most important greek at the moment is simple, deltas. It is about +35 deltas and with the short strike being 20 dollars away, is essentially like being long 1/3 of the underlying with defined risk if the stock craters from here (max risk 5.25 or about 3% of the underlying stock) but also the potential to be just like stock for a move towards the short strike of 180. That’s because as long as the stock is above 160 into December expiration the more like real stock this trade will become. Below 160 and it acts like an out of the money 160 call.

So how to manage the trade? If still bullish into year end, leaving it as is is probably the best bet. The trade got you through the potentially volatile event and is no harm no foul with the stock in the same spot. The reasons for having it on in lieu of long stock still holds, event or no event. The stock remains at a critical spot on the chart with the stock attempting to stay above the 200 day moving average around $158:

[caption id="attachment_58184" align="aligncenter" width="675"]Screen Shot 2015-11-02 at 9.36.32 AM 1 yr AMGN from LiveVol Pro[/caption]

Of course, the tone of the original post wasn’t meant to be bullish. This was a defensive trade. After climbing from 130 to 160 in such a short time, and with everything going on in Biotech at the moment, risking 3% (vs unlimited in the stock) at a critical juncture seemed the way to go. If you replaced the stock with this trade, and now don;t even feel like sticking around at all, the trade can be taken off for around even. Again, no harm no foul and a fairly cheap look into the event.