Evolus: High Implied Volatility Brings Opportunity

Summary

• The company is awaiting a decision from the ITC concerning the use of Jeuveau in the US.
• Implied volatility is well over 240%.
• The stock is dirt-cheap if the ban is not inflicted.
• Risk is high, however, so we are leaning towards a volatility play instead of a directional one.
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Evolus Inc. (NASDAQ:EOLS) came across a screen we ran where our objective was to find low-priced companies which were trading with high levels of implied volatility and which had ample liquidity in their options. We like to trade high-implied volatility companies within our portfolio, as they bring an extra dimension to the portfolio. The reason being is that they bring extra diversification because many times these trades involve a volatility crush. What we mean here is that we merely sell option premium instead of trying to ascertain a direction on the trade.

If we look at Evolus' chart at present, we can see that shares have been basically making lower lows since mid-2018. The recent lows in October though of this year leads us to believe that we may have a double bottom or most likely an inverse head and shoulders reversal pattern being played out at present. We favour the latter (inverse head and shoulders) because the October dipped slightly below previous July support. The bottoming pattern looks probable because of the bullish divergence in the RSI indicator and because of the recent third-quarter numbers and trends.

Although reporting a negative bottom line earnings number (-$0.33) in the most recent third quarter, Evolus lost less than expected. The pandemic-induced lockdowns hit the company hard this year, but its rate of losses has been sharply decreasing in recent quarters. Analysts who follow this stock expect the beauty company to report -$0.24 in Q4 and then -$0.10 in the first quarter of next year.

The bullish expectations come on the back of a growing account base, increasing re-order rates among existing customers and strong take-up of the company's loyalty program. Evolus is the typical “non-essential” type of company which should do very well if pent-up demand increases as people become vaccinated. Revenue trends continue to improve and are expected to hit almost $22 million in the fourth quarter. Management will be hoping that renewed demand, along with lower costs due to higher digital use, will result in sustained earnings growth going forward.

(Source: Company website)

However, the canary in the goldmine remains the pending decision from the ITC (International Trade Commission) concerning the use of Jeuveau in the US. If the decision goes against Evolus, it would be catastrophic, as Jeuveau is essentially the company's only product, and it would constitute a 10-year ban of Jeuveau within the US. The decision has been delayed on multiple occasions, which has given Evolus ample time to lobby the US government to try and keep selling its Botox alternative treatment in the US market.

Suffice it to say, there is no doubt that Evolus will rally aggressively if the decision goes for the company. Furthermore, there is ample runway for growth in Europe. What, though, about the alternative? This is what investors need to take into account, as this pending announcement is what essentially is creating all the fear at present. Remember, the improving financials above do not paint the full picture.

Therefore, our play here would be to not pick a direction, but instead, sell the fear which is evidently apparent in shares at present. As we can see from the implied volatility chart below, IV currently in EOLS is 246%. Although this number is well above average, what we are more interested is in how much its present implied volatility is above the long-term mean. As the chart illustrates, one could state that the long-term mean is well under 100%. Implied volatility always retraces to its long-term average over time.

Our play here would be to sell premium aggressively and wait for IV to contract. For example, an at-the-money $1 wide iron condor looks appealing in that one can receive plenty of premium in a defined risk setup. Having a defined risk trade where one can receive this amount of premium stacks the odds considerably in favour of being able to make some type of profit on the trade.

(Source: Interactive Brokers)

Therefore, to sum up, if the pending decision goes in favour of Evolus, there is no doubt that we will witness an aggressive spike upward in the share price. However, given the lack of assets on the balance sheet, along with the fact that the firm relies heavily on Jeuveau, our play here is to sell the rich option premium which is on offer. We will put something on in here shortly.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.