Tuesday, March 5, 2013

VRX: Pharmaceutical bull signal

Update 4/21/2013: My vertical credit option spreads against VRX expired worthless, for a yield of 37.7%.

Update: VRX on April 4 broke below $70.88 -- the lower boundary of its 10-day price channel -- triggering closure of a portion of my bull position for a 0.8% loss on the underlying stock.

My VRX position was complex: Short vertical option spreads expiring in April for the initial position and long calls for the 1st, 2nd and 3rd adds. The long calls were closed immediately upon the signal for a 1.4% loss on the underlying and an 18.4% loss on the calls themselves.

In accordance with my rules, I'll continue to hold the spreads with a stop/loss at the breakeven point, $66.84. The verticals will be closed at a profit if the price stands above the break-even point on the April 20 expiration. 

Valeant Pharmaceuticals International Inc. (VRX) on Monday moved above its 55-day and 20-day price channels in yet another leg of a stair-stepping rise that has carried it from $55.15 on Dec. 4 to a high today (so far) of $70.10.

The rise is part of a broad and persistent uptrend that has been in force since October 2008, whose most recent major correction to the downside ended in October 2011 the present, mid-term push to the upside from $32.05.

The breakout above $68.50 was confirmed by the stock trading above that level today.

It's a bullish chart, one that is borne out by the odds of upside success.

Since early 2009, when the broad markets began their rise from the recession crash, VRX has sent 19 bull signals, 11 of which were successful, for an average return on the winning trades of 14.1%.

Since October 2011, when the present mid-term leg up began, VFX has broken out to the upside six times, and four of those have produced a profit, averaging 8.9%.

Valeant, headquartered in Montreal, Quebec, is a pharmaceutical company focusing on neurology, dermatology and infectious diseases. Its flagship product is Kinerase, used as an anti-aging agent for skin.

The stock is traded both on the NASDAQ and the Toronto Stock Exchange.

VRX has found favor with analysts, whose collective opinions produce an enthusiasm rating of 29%.

And no wonder. The company reports a 36% return on equity. Although that comes at a high price in debt, amounting to nearly three times equity.

The company has been profitable the last 12 quarters with steadily growing earnings. The quarterly reports have surprised 11 times to the upside and once to the downside, the latter being in 2010.

Institutions own 85% of shares and have bid up the price to a fairly astounding level. It takes $5.84 in shares to control a dollar in sales.

VRX on average trades 1.4 million shares a day. Even at that low level, it supports a good selection of options strike prices with open interest in the three- and four-figure range.

The front-month at-the-money bid/ask spread on calls is 4.8%, a very narrow range for a stock with volume below 2 million.

Implied volatility stands at 34%, in the bottom half of the six-month range, and has been zig-zagging down since late February.

Put options are trading 10% above their five-day average volume, and calls at about halfof averaging volume, putting a bearish cast on near-term speculation.

At several points in the following analysis I use the concept of two standard deviations, a statistical tool that encompasses 68.2% of something out of a total universe. In this case, I'm applying the tool to trades.

Options are pricing in confidence that 68.2% of trades will fall between $62.86 and $76.68 over the next month, for a potential profit or loss of 9.9%, and between $66.45 and $73.09 over the next week.

Today's fair-price zone ranges from $59.10 and $69.81, encompassing 68.2% of transactions surrounding the most-traded price, $69.61. VRX moved to the most traded price in the the first half hour of trading and has been priced near that level in the first 90 minutes of trading.

Valeant next publishes earnings on April 29.

Decision for my account: I've opened a bull position in VRX, structuring it as a bull put spread expiring in April, short the $67.50 put and long the $65 put. The position is profitable down to $66.85, below the initial stop/loss point.

The position provides a 3:1 risk/reward ratio with a 39% maximum yield. If the stock continues to rise, I shall add to the position by buying long July calls with deltas as close to 70 as I can manage.


My trading rules can be read here.  A discussion of recent modifications to my trading methods, which haven't yet been incorporated in the original write-up, can be found here.

And the classic Turtle Trading rules on which my rules are based can be read here.

Tim Bovee, Private Trader tracks the analysis and trades of a private trader for his own accounts. Nothing in this blog constitutes a recommendation to buy or sell stocks, options or any other financial instrument. The only purpose of this blog is to provide education and entertainment.
No trader is ever 100 percent successful in his or her trades. Trading in the stock and option markets is risky and uncertain. Each trader must make trading decision decisions for his or her own account, and take responsibility for the consequences.

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