Alexander Valtsev
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Going Risk-Free With Horizon Pharma

One of my previous articles on an arbitrage strategy involving SolarCity’s (SCTY) shares and options caught a lot of attention from the Seeking Alpha’s community. I noticed a few comments saying that the strategy was hard to implement or almost impossible because SolarCity’s shares were unavailable for short-selling at some brokerages (the idea was to buy the synthetic and sell the shares short in a delta-neutral manner). I agree that this was a great idea from a theoretical standpoint but a bit difficult to execute without extra costs (such as interest on shorted stock). Today, I will show a strategy that will not require any short-selling from investors.

My newest idea involves Horizon Pharma Plc (HZNP). I find that many arbitrage strategies revolve around stocks that are found in special situations, and Horizon Pharma is definitely one of these cases, following the most recent quarterly report. I personally do not think the results very bad. However, big banks’ analysts have recently been playing an increasing role in moving the markets (recall LinkedIn and FedEx, for example). I have read an opinion stating that the stock went down due to a subpoena issued to the company in relation with its marketing activities (see the company’s 10-K) but I currently do not have any own thoughts to share about it. In any case, the stock got hammered as the company lost over a quarter of its market capitalization in just one day:

(Source: Bloomberg)

The strategy I am offering today is essentially the same as in the case of Valeant Pharmaceuticals (VRX), which I covered more than a week ago :

(Source: TD Waterhouse)

Note: The above table shows prices for options expiring on January 19, 2017. I used mid-point prices to obtain figures for calculations. The actual transaction prices at which readers may execute the strategy may differ from broker to broker.

The algorithm is the following: sell at-the-money calls (strike of $15), buy at-the-money puts (strike $15), and buy the stock (the market price at the time of writing was $14.07).

As a result of this trade, investors have to pay cash upfront (buying the stock is the biggest cash outflow here). I hope that readers will not face problems buying Horizon Pharma’s stock, especially given the fact that it is under downward pressure.

Here is the profit/loss profile of this trade:

(Source: author’s calculations)

As readers can see, investors lock a profit of $18 per contract (100 shares of stock). The optimal trade size, given transaction fees and taxes, is 10 options contracts (1000 shares of stock). In terms of profitability, this arbitrage trade yields a ~1.3% return through January 2017 (a ~1.5% annualized return), fees and taxes excluded. The strategy is delta-neutral at initiation and remains so throughout its life, so investors will not have to worry about any rebalancing.