- Shares have been rallying aggressively on Covaxin potential.
- The market continues to price in an aggressive move in shares.
- Instead of focusing solely on direction, our play would be to sell the elevated implied volatility on offer.
- This brings an extra component to the set-up.
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If we look at a daily chart of Ocugen (NASDAQ:OCGN), we can see that shares broke out of consolidation last December on very strong volume. The consolidation zone lasted more than two years which is significant. The reason for the breakout was due to the announcement of a vaccine partnership with Bharat Biotech. The partnership revolved around Covaxin (Bharat's COVID-19 offering) and how it could be developed for the US market.
The gap on the chart below also is significant. When these gaps take place on strong volume after a prolonged period of time, it usually means a sustained move to the upside is in its initial innings. Furthermore, as we can see below, the gap has not been filled as of yet which is another bullish sign. Authentic breakaway gaps should always act as very strong support and with good reason.
The reason being is that if indeed a brand-new trend has begun in this stock, price has absolutely no business falling below the middle part of the gap. Although the announcement of a vaccine scientific advisory board definitely brought down the hype (along with some negative news concerning Bharat) in the aftermath of the Covaxin announcement, what was crucial was that price remained above support and that is what indeed has played itself out.
Then at the start of February, shares received another boost to the upside once more on strong volume. Shares rallied aggressively in February on the back of a multi-million capital raise. Obviously, the potential is huge in this space especially with multiple variants of the virus coming on the scene in recent weeks. It looks like vaccines are most certainly here to stay for the foreseeable future and Ocugen has gone into the business with a partner with a track-record in this area.
The other side of the argument here is with respect to downside risk and that Ocugen has no revenue to speak of and currently reports less than $20 million of equity on its balance sheet. The company’s present market cap is $1.88 billion.
So, from our standpoint, the question is how can we take advantage of the hype whilst also keeping our risk in check. Obviously, one could simply take a small long position here but our play here would be to use the sky-high volatility to put on something like a put spread or even a naked put. We will go through a naked put for simplification purposes as it is only a one-leg trade so it is easier to manage.
Implied volatility in the April cycle is well over 300% and only fractionally behind the March cycle. Therefore, we would prefer to go out to the April cycle to avail of the extra extrinsic value which means more premium can be collected. The last realized price of the $7.50 put was $2.60 per contract. If we were to sell this put and the stock were to stay above the strike price ($7.50), then we would get to keep the full premium if we held the contract until expiration.
On the other hand, if the stock was trading below $7.50 at expiration in April, we essentially would get “put” the stock which means our cost basis would become $490 per contract. This means, that if we were to hold this put contract until expiration and the price of OCGN was in the money (under $7.50 per share), $4.90 would be the cost-basis of our shares – almost a 50% discount on where shares are presently trading.
Given though what we discussed above with respect to the huge valuation Ocugen is presently trading at, the question is would we want to be long Ocugen at $4.90 per share? If not, we would roll the contract out in time for a credit well before the contract expires. What this does is it reduces our cost-basis below $4.90 which essentially reduces our risk. This is how we play defence as it is much easier to play defence in low-priced stocks because there is only so far a stock can fall. In fact, if implied volatility were to remain "highish" in here, one could roll out into perpetuity which would keep reducing the cost-basis of the position and downside risk as a result.
Therefore, to sum up, instead of looking at Ocugen as a stock with huge upside potential, elevated risk remains especially when you look at the valuation and current financials of the company. We would favor something like a put spread, ratio spread or even naked puts to take advantage of the elevated implied volatility on offer. We look forward to continued coverage.
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This article was written by
Analyst’s Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in OCGN over 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.
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