The pharmaceutical sector continues to provide a rich source of returns in these markets, but if prices turn south, will Dexcom still offer a sweet spot?
Because Dexcom focuses on diabetes, a pervasive disease, it provides a fertile ground for returns using options.
The stock holds a Composite Rating of 90, and the industry group rank is 25th out of 197.
From a trading formation, this stock suggests to me that buying it outright warrants caution. That said, medical products that focus on diabetes are likely to have a fair bit of runway in the months and years ahead, so let's consider ways to profit from keeping our eyes on this stock.
Let's consider a combination of two strategies involving options with the goal being to collect as much premium upfront and minimizing our risk.
As we continue looking at positions in the options space, we will add more complex opportunities. The market environment is not rewarding risk currently, especially as volatility as measured by the Cboe Market Volatility Index (or VIX) is sitting dangerously close to areas that have seen markets turn south.
Identify Key Chart Levels
First, a look at key chart levels. Sellers sit firmly near the 120 region, buyers near 100. The price trend is mixed, so ranges are likely to expand and then return to congestion.
The value trader wants to acquire Dexcom but feels that the current price is a premium and wants the stock to go on sale. The value trader wants to participate at support levels near 100. The risk is that this stock could drift deeply near 80 (the lower line in the illustration), so let's keep that in the back of our mind when we determine where stops lie.
Let's look at a combination of revenue-generation options. My preference is always to sell premium in low-volatility readings, like when the VIX is below 35. Once the VIX moves above 35 to 40, we must reconsider risk there.
Low volatility portends price action to be stable. I want prices in the stock to be relatively stable without wild swings if I am selling premium so close to the actual price of the stock.
If the VIX begins to rise above 40, we now know that the market makers and risk takers are suggesting that a rise in premium is required to offset the risk of engaging in the option. This will make me sell option strikes much further out of the money.
The value trader is content to position in order to accumulate at the relative price of 100, but also willing to surrender the stock while the market is rocky.
Strategy Works Well For Sideways Trend
This options strategy works well when we are looking at a stock that has a sideways weekly trend.
Looking at the March option chains, we can see the 100 puts show a mark or midpoint at $4.25.
Selling the March 100 puts for a credit of $4.25 will commit you to owning 100 shares if Dexcom's stock price drops to 100.
If we collect a $4.25 credit, and we do get to acquire the stock at 100, we actually pay $9.75 (less trading fees), which is very close to the support region that I stated.
In addition to selling the 100 put, we will sell a vertical call spread that increases our premiums collected.
Sell the March 120 calls and buy the March 125 calls for an additional premium of 1.60.
Our total premium is now $5.70 and if we are but to the stock, we got it at the price of 94.30.
Possible Scenarios With Dexcom Option Trade
What could happen:
- Stock rallies and it never comes back to 100 and moves all the way beyond $125: The result for the trade is that we are underwater in our call spread by the difference between strikes — $5. But we collected $5.70, so we are still in the green by $.70.
- Shares rally and never come back to 100 but never breach 120 by expiration: The result is that we keep all the $5.70 in premium.
- The stock fades and we get put to the stock at the cost of $94.3 (less fees) and the stock bounces from there.
- The stock fades, we enter into the trade and are stopped out by the risk we have set aside for the position.
The uniqueness of this trade is that there are three ways to capture revenue and only one way to see a loss. In my book, those are acceptable risks — especially with the IBD rating it holds.
