The War on Drugs – Gilead (GILD)

by riskreversal September 28, 2016 3:02 pm • Trade Ideas

We’re not getting to hear much policy discussion in this strange presidential election cycle but one topic that sometimes gets through is healthcare. A hot button issue over the past year on the Democratic presidential campaign trail has been drug pricing and on the Republican side been the costs of Obamacare. Oddly, neither topic came up in Monday night’s debate between Clinton and Trump.

Since Trump tightened up what looked like a run-away lead for Clinton just weeks ago, Biotech stocks have caught a bid, which makes sense on the drug pricing front. The S&P Biotech etf (XBI) has gained 15% since August 31st, nearing the break-even point on the year, and marking a 55% rally from its 2016 lows made in February:

[caption id="attachment_66670" align="aligncenter" width="600"]XBI ytd chart from Bloomberg XBI ytd chart from Bloomberg[/caption]

CNBC tech reporter Meg Tirell joined the Fast Money desk last night to discuss the performance (or lack thereof) of mega-cap Gilead (GILD) and the rating downgrade from Leerink Partner’s analyst Geoff Porges (who also joined us):

Porges argues that the stock’s massive under-performance to the group (down 22% ytd, down 35% from its all time highs made in mid 2015) is the result of their slowing HepC franchise, despite its great success. Porges’ sense now is that the company will need to make a large acquisition in the rare disease space to accelerate the potential for growth.  He argues against the sort of tuck in $1-2 billion acquisitions the company is known for as there are few if any on his radar that could move the needle on its $30 billion revenue base.

Taking a quick look at the GILD chart, it’s hard to find a $100 billion mega-cap stock in the U.S. that has acted this poorly over the last year. Some might even call the formation over the last few years the triangle of death:

[caption id="attachment_66671" align="aligncenter" width="600"]GILD 5yr chart from Bloomberg GILD 5yr chart from Bloomberg[/caption]

Short dated options prices in GILD have recently ticked up, despite realized volatility very near 52 week lows as the stock has ground down to 52 week lows (while the SPX is just 2% from its all time highs):

[caption id="attachment_66672" align="aligncenter" width="600"]From Bloomberg From Bloomberg[/caption]

The next identifiable catalyst for GILD will be Q3 results the last week of Oct, and investors will likely be focused on any commentary about m&a after the company’s $5 billion debt raise earlier in the month.

So What’s the Trade?

Entries on the long side are tricky here with failure down to the 60 level not impossible. So for those looking to get involved for a reversal of the recent downtrend, defining risk is prudent:

GILD (78.50) Buy the Nov 77.5/87.5/97.5 call butterfly for 2.75
  • Buy 1 Nov 77.5 call for 4.05
  • Sell 2 Nob 87.5 calls at .70 (1.40 total)
  • Buy 1 Nov 97.5 call for .10

Rationale – this trade starts in the money, breaks even at 80.25 and has a max gain of 7.25 at 87.50 in the stock, which happens to correspond with the 200 day moving average (currently 87.87), which is a good spot to target on the upside. The biggest risk is if the stock goes down between now and earnings, or if earnings produces a large gap lower. But risk is defined to 2.75. That is 3% in the stock, which may seem like a lot, but the implied move in the stock between now and November expiration is more than twice that. And this is a stock that has been hard on its last two earnings reports (blue E’s):