As of Friday's close of the market, four pharmaceutical stocks presented investors with intriguing in-the-money covered call trades. Potential annualized returns from these positions range from 114% to 265%. Whopping returns like this don't come without an outsized amount of risk. So, do your due diligence before investing.
Starting with one position I am hesitant to recommend, let's examine the calculation provided by the Options Industry Council. An in-the-money covered call position with Questcor Pharmaceuticals, Inc. (QCOR) provides the opportunity to sell a $29 call option with an October expiration for $4.10 per share. The stock is trading at a little over $30, making this call better than $1 in-the-money. As the calculation shows, the option has a very rich premium, potentially generating a $2.77 profit for the call seller. This generates a potential return of 10.6% if the price of the stock stays above $29 at expiration. If the stock falls, the trader will break-even at $26.23.
However, you must do some due diligence before trading. Looking at a stock chart, plotting a simple 30-day moving average, you can see that the stock recently sold off significantly from highs in the $50 range.
This type of technical movement may continue and that would not be a good thing for anyone holding the stock. Looking through recent news headlines, it appears that the company has lost coverage from Aetna on their largest drug, Acthar. This could spell trouble in the short-term.
Another potentially lucrative covered call trade involves Isis Pharmaceuticals, Inc. (ISIS). Holders of the stock could sell an October 2012 $14 strike price call option for $1.90 against their shares which are currently trading above $14. If the shares continue to trade above $14 at expiration, then the trade will generate a 10.5% return for the investor. This represents a 134% annualized return. If shares fall below $14, the shares will continue to be held by the investor and the break-even price for the trade is $12.67, or 11.8% below the current price.
Unlike Questcor, Isis shows strong fundamentals, steadily appreciating from around $7 in mid-April to over $14 today. From the latest 10Q filing, one could learn that revenue for the quarter ended June 30, 2012, nearly doubled versus the prior year quarter and the company managed to lose only a penny. This fits the definition of a strong growth stock. After doing some due diligence, you may be interested in holding these shares outright, but the covered call trade looks promising as well.
Peregrine Pharmaceuticals, Inc. (PPHM) stock currently trades around $5.39 and the $5 strike price October 2012 call option could be sold for a premium of $1.00. Even factoring in moderate commissions, this trade yields about an 8.9% return over the next 28 days, which represents an annualized return of 114.8%, assuming shares continue to trade above the $5.00 strike price. If shares fall below $5, the holder of shares will retain ownership and the break-even price on those shares becomes $4.59.
In the latest 10Q filing, the company reported a narrower loss of 7 cents per share, versus the prior year quarter. That, in itself, doesn't capture the driving force behind the 12-month chart, which clearly shows upward momentum.
The most intriguing trade of the four would be Sarepta Therapeutics, Inc. (NASDAQ:SRPT). With the stock trading at $14.47, you can sell the October 2012 $12.50 strike price call option for $4.30. This generates a potential profit of 20.5% over the next 28 trading days. Annualized, this represents a return of 264.1%, which is exceptional. However, if shares fall below $12.50, you could lose money. The break-even point on the trade is $10.37, or 28.3% below the current price.
As the stock chart indicates, the company is in the process of moving through a Duchenne muscular dystrophy drug trial, with milestones significantly affecting the market price of the stock. A significant milestone came July 24, which boosted the stock's market price on heavy volume.
With biotech stocks such as these, the future outcome of the company and stock may be dependent upon one drug trial, or product offering. Good news and bad news significantly affect volatility. These trades attempt to profit from volatility, while limiting potential returns. Do your own due diligence.
Disclosure: I 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.