Alexander Valtsev
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Don't Sell Gilead - Sell Options And Buy The Stock Instead

Gilead Sciences's (GILD) stock is crashing in the after-hours trading as the company's quarterly results did not satisfy analysts' expectations:

Note: the stock is currently trading below $92 per share, according to data from Google Finance.

Here is the data that shaved off over $7.2B from the company's market capitalization in just a couple of hours:

(Source: Seeking Alpha)

Should you sell the stock when this sort of situation appears on the market? Surely, no. First, remember the rule: buy low, sell high. This is the fundamental rule of investing. Secondly, the first rule only applies for good stocks. Gilead Sciences is a good stock - the company has solid financials and its shares are traded at very low earnings and cash flow multiples:

(Source: Google Finance)

Okay, sales are down on a Q-o-Q basis, the bottom line has dropped. But what about the company's historical records? Let us look at the bigger picture:

(Source: Google Finance)

As you can see, quarterly revenues are growing, annual cash flows are on the rise, and the company has been increasingly generous towards its shareholders, returning almost $15B (over 10% of current market capitalization) in the form of buybacks and dividends. In addition, the guidance for 2016 has been confirmed. The stock is trading at 7.5 - 8.0x last-twelve-month earnings or about 6.5 - 7.0x annual operating cash flows. This is not only cheap in absolute terms but also relative to like-sized peers.

If you are a Gilead Sciences's shareholder, please hold on and buy some stock on the dip. In addition, sell some May 6th straddles as long as volatility is high:


The P&L chart is given below:


Note that the figures used for calculations have not been updated yet because the markets are currently closed. The figures will change tomorrow with the market's opening.

You are exposed to unlimited downside risk with this strategy (technically, your risk is limited to the price of $0 but it is still very substantial). On the other hand, given that you are long the stock, you are already accepting this risk. Moreover, there are no reasons to believe that the company is going bankrupt anytime soon, especially during the one-week period selected for the options.

Your upside exposure is hedged by the long position in the stock (in-the-money options and the underlying move in the same direction with the same "speed", governed by the Delta). In addition, as the market data has shown for some recent earnings participants, like Twitter Inc. (TWTR), Netflix Inc. (NFLX), and Apple Inc. (AAPL), the market participants tend to not drive share prices higher right after they have significantly tumbled. In fact, the market tends to become really calm after it has committed a slaughter. Hence, this is a very good time to sell options - there is little volatility on the market, which crashes the options' values, and the fast time decay further benefits the seller. 

This particular trade aims to earn a 6.5%+ return in just seven days. This does, in fact, cover the loss in the underlying, which you would otherwise have to swallow. If the stock keeps going lower and crashes through the bottom break-even level of $88.55, you get to buy the stock even cheaper (and earn a higher dividend yield thereon). If the stock heads higher, you will simple buy less shares at a higher price. However, if you have already bought the stock at a higher level, this is should not be a problem for you. On the other hand, I assess the probability of the stock rising sharply in the next week as very low. Even though the quarterly results were not bad, the stock still does deserve a beating. I think that it will not start moving substantially upwards over the next week (the next important meeting, a conference with Bank of America Merrill Lynch, which can affect the market for the stock, is not due until May 10).

 Take a look at this opportunity again and let me know what you think. Remember: there are always options with options (pun intended).