Arcángel de Jesús Montoya
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Arcángel de Jesús Montoya in Money Trafficking,

Sell Endo International`s Covered Calls On Monday

Endo International plc (ENDP) is a global specialty healthcare company focused on branded and generic pharmaceuticals and devices. It operates through four segments: U.S. Branded Pharmaceuticals, U.S. Generic Pharmaceuticals, Devices and International Pharmaceuticals. It has a portfolio of branded pharmaceuticals offered by its U.S. Branded Pharmaceuticals segment that includes brand names, such as Lidoderm, OPANA ER, Voltaren Gel, Percocet, BELBUCA, Fortesta Gel, Testim, Aveed, Supprelin LA, and XIAFLEX (Source: TD Waterhouse). It is reporting earnings on Monday, August 8, after market close:

(Source: TD Waterhouse)

As evident from the above, the company beat earnings estimates in 100% of time in the last eight quarters and has seen substantial volatility in the market price of its stock over the last three months:

The market participants expect the following numbers over the next few quarters, including the upcoming one:

(Source: TD Waterhouse)

Market data show that the August options are a bit overvalued:

(Source: TD Waterhouse)

The two-week straddles (options with a strike price of $18.00 and expiring on August 19, 2016) are worth around 16.2% of the current market price of the stock. Historically, the stock has been more volatile than that on a monthly basis over the last year:

(Source: Google Finance. Calculations by author)

As you can see, the stock has had a monthly standard deviation of 23.2% over the last 52 weeks, while the straddle expiring in a bit less than three weeks has an implied monthly volatility of around 16.0% (calculated based on 10 business days remaining until expiration), also including volatility from the earnings event next week. I therefore see signs of modest overvaluation in these options. Hence, selling the straddles is a good idea from a theoretical standpoint.

Investors may also be interested in selling call options against the stock to lower the cost basis of their holdings:

(Source: optionsprofitcalculator.com)

On the one hand, this will limit expected returns. On the other hand, this action will minimize losses in the event the stock goes south over the next two weeks. The risk-return profile of this trade looks like this:

(Source: optionsprofitcalculator.com)

As you can see from the above illustration, Endo's investors can pocket a 222% annualized return in these three-week calls. On the other hand, if the stock goes higher than $19.50 per share (an increase of over 5%) in the next two weeks, they will get a ~230% annualized return (the premium from the calls and the upside from the stock up to $19.50 per share).

What do you think of this trade?