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Michael Haden's Insights

InvestorsObserver
Options Analyst Writer
Michael Haden
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May 18, 2015 - Vertex Breakthrough Drug can be a Breakthrough for Your Portfolio

With most industries producing flat results for the year, biotech has been one of the few sectors delivering reliable returns to shareholders. Within this group, Vertex Pharmaceuticals is poised to continue with a strong showing for the remainder of the year. The company is on the brink of approval of a new cystic fibrosis drug, ORKAMBI. The new drug will provide a treatment for the underlying causes of Cystic Fibrosis, suitable for a broad range of patients.

ORKAMBI has received approval from an independent panel of medical experts by a 12 to 1 margin. Vertex now awaits the final approval of the Food and Drug Administration on July 5.

Vertex has not announced pricing plans for the new drug, but currently sells a treatment for a much smaller group of patients at $300,000 per year. ORKAMBI is expected to generate profits in the billions of dollars for Vertex.

In order to capitalize on VRTX stock’s consistent performance, we will look for a covered call that will allow us to reap the benefits of the company’s encouraging prospects while taking in additional premium gained from selling a call against the stock. The premium from our sold call will also provide us a cushion in the case that the stock should take a downward turn.

While we can expect the stock to continue to hold its own, we should be aware of the possibility that we may have to sell the shares at the strike price of our call. Given past performance, VRTX is unlikely to make the sudden upward spike that could cause our shares to be called away.

 

Chart courtesy of www.stockcharts.com

We will buy 100 shares of VRTX stock trading at $123.08. At open, we will sell a July ‘15 $120 call for $11.00 against those shares. We pay $12,308.00 for our 100 shares of VRTX while we receive $1100.00 for the call option. This gives us a total investment of $11,208.00, or $112.08 per share. Our target return for this trade is 7.1%. To cause a problem for us, VRTX stock will have to drop by 8.9%.  

Let’s look at the possible outcomes of our trade:

At expiration, VRTX may be above the strike price of $120.00 In this case, our call will be assigned and we will sell our shares at $120.00, which is slightly more than we paid initially. Since we received that $11.00 per share credit up front, our actual cost basis is $112.08. This means that by selling at $120.00 we take in a profit of $7.92 per share.

On the other hand… at expiration, the price of VRTX stock could be below $120. In this case, our sold call will expire worthless and we will get to keep both the original credit we got for selling it and our underlying shares.  At that point we will be able to sell another call if we like and continue to take in profits.


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