Alexander Valtsev
2
All posts from Alexander Valtsev
Alexander Valtsev in Alexander Valtsev,

Earn A 58%+ Return On Sarepta Therapeutics Next Week

Sarepta Therapeutics (SRPT) is a hell of a stock: the volatility in the last week was insane. As opposed to Netflix (NFLX), which simply crashed by about 10% after earnings, SRPT actually bounced back and erased some of the previous day's losses:

As you can imagine, SRPT's options have become very expensive now: in fact, their implied volatility is in the triple digits. I am talking about options expiring a week from now:

(Source: Yahoo Finance)

When options are this expensive for such a short period of time, there are two things you can do: (1) avoid them and watch for the auction on the sidelines or (2) sell them.

I like the second choice more. Why is that? Well, I found a strategy that involves selling the expensive options, while also limiting risks. Strategies like iron condor or butterflies, which I have suggested in the past, do not work here for the simple reason that all options on the board are expensive. Hence, there are no real spreads you can capitalize on in this case using butterflies or iron condors. Therefore, I would like to introduce a new strategy to you - covered strangles. The algorithm is simple: sell out-of-money puts and calls and buy shares simultaneously (make sure that the quantities are the same). In this particular case, I have chosen two strike prices: the $18 call and the $112 puts. Each of them is about $3 away from the current market price of the underlying (or about 20% away). This pair costs at least $5.65 per contract, which translates into an almost 40% potential return over a course of one week! 

Of course, there are also risks with this strategy. For example, this trade is exposed to unlimited downside risk. Theoretically, the stock can go to zero, and the trader will be left with a worthless stock with an obligation to buy it from the market at the put's strike price. Fortunately, the loss is partially offset by the call's and the put's premiums. The upside is capped by the strike price of the call. Generally, you can view if as a non-directional strategy, which typically has the following risk-return graph:

(Source: plcharts.com)

With the setup I have outlined above, the risk-return table going forward looks like this:

(Source: optionsprofitcalculator.com)

As you can see, the maximum return here is the price of the spread received from the options' buyers and the difference between the strike price and the market price of the stock. The downside is capped by zero. The break-even is at just below $11 per share (about 30% below the market price of the stock) and calculated as the current market price of the stock less the premiums received from the sale of the stock.

Exit Options

The ideal scenario for the stock is to go above $18 per share until April 29, 2016. This way, the trader gets a profit of about $8.70 per share.

If the stock remains roughly at the same level, investors will keep the premiums (about $5.60 per share) and simply sell the stock on Friday before close. This will translate into a ~40% return less transaction fees and taxes.

If the shares start sliding down, set a stop loss at just above $11 per share to make sure you break even on the trade in the worst-case scenario.

In short, I like the risk-reward ratio in the trade and the current setup. I am waiting for Monday to look closer at this trade.