Option Idea Which Must Be Executed Before Market Closes November 1st
I am sorry to send you a second email message today, but I need to hurry because it will disappear tomorrow. It involves Gilead Sciences (GILD)
Gilead (GILD) announces earnings on Tuesday, November 1st after the close. The post-announcement options are extremely expensive. Implied Volatility (IV) for the 04Nov16 series is 60 compared to 34 for the 16Dec16 series which expires six weeks later. The company has fallen 32% from its 52-week high and pays a dividend of 2.5% and has a p/e of only 6.4 which should provide some level of support. Expectations are for lower sales and earnings. These facts support the idea that a big drop in stock price is unlikely after the announcement. This trade will make money if the stock is flat or goes up by any amount (a maintenance requirement of $400 per spread, less the amount of the credit, will result):
Buy To Open 1 GILD 16Dec16 70 put (GILD161216P70)
Sell To Open 1 GILD 04Nov16 74 put (GILD161104P74) for a credit of $.25 (buying a diagonal)
We bought 5 contracts of exact spread today in our portfolio that trades on earnings announcements. It will make a maximum gain if the stock closes on Friday exactly at $74. Any price higher than that will also result in a profit. The stock should be able to fall about $2 before any loss should appear on the downside.
This is the risk profile graph for this spread, assuming that IV for the 16Dec16 series falls by 5 after the announcement:
The theoretical risk of this investment is $375 (the $400 maintenance requirement less the $25 received). However, since we plan to close the spread on Friday and there will still be 6 weeks of remaining life for the 16Dec16 70 put, the actual risk is far less than $375. That is the amount that you will tie up in your account for this week, however.
You can see that if the stock is flat or moderately higher on Friday, you will make a profit of about $100 on your $475 investment, or about 25%. Not bad for a week.
If the stock falls by more than $2, the graph indicates that a loss would result. Since we believe the low valuation and the high dividend rate both provide a solid support level for the stock, we don’t believe the stock will fall by very much, and we feel good about making this investment.
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