Eli Lilly (LLY) is showing elevated implied volatility with an IV Percentile of 98%, and that could mean it’s a good time for an iron condor trade.
An iron condor aims to profit from a drop in implied volatility, with the stock staying within an expected range.
When implied volatility is high, the wider the expected range becomes.
The maximum profit for an iron condor is limited to the premium received while the maximum potential loss is also capped. To calculate the maximum loss, take the difference in the strike prices of the long and short options, and subtract the premium received.
LLY IRON CONDOR
Traders that think LLY stock might stay in the current range over the next few weeks could look at an iron condor.
As a reminder, an iron condor is a combination of a bull put spread and a bear call spread.
The idea with the trade is to profit from time decay while expecting that the stock will not move too much in either direction.
First, we take the bull put spread. Using the February 9 expiry, we could sell the $565 put and buy the $555 put. That spread could be sold yesterday for around $1.75.
Then the bear call spread, which could be placed by selling the $700 call and buying the $710 call. This spread could also be sold yesterday for around $1.10.
In total, the iron condor will generate around $2.85 per contract or $285 of premium.
The profit zone ranges between $562.15 and $702.85. This can be calculated by taking the short strikes and adding or subtracting the premium received.
As both spreads are $10 wide, the maximum risk in the trade is 10 – 2.85 x 100 = $715.
Therefore, if we take the premium ($285) divided by the maximum risk ($715), this iron condor trade has the potential to return 40%.
If price action stabilizes, then iron condors will work well. However, if LLY stock makes a bigger than expected move, the trade will suffer losses.
COMPANY DETAILS
The Barchart Technical Opinion rating is a 100% Buy with a strongest short term outlook on maintaining the current direction.
LLY rates as a Strong Buy according to 17 analysts with 1 Moderate Buy ratings and 2 Hold ratings.
Eli Lilly and Company, one of the world's largest pharmaceutical companies, boasts a diversified product profile including a solid lineup of new successful drugs.
It also has a dependable pipeline as it navigates through challenges like patent expirations of several drugs and rising pricing pressure on its U.S. diabetes franchise.
Its pharmaceutical product categories are neuroscience, diabetes, oncology, immunology and others.
Over the past few years, Lilly has been actively seeking acquisitions and in-licensing deals to boost its product portfolio and pipeline.
The purchase of ImClone Systems brought with it cancer compound, Erbitux.
The acquisition of ICOS Corporation gave Lilly full control over erectile dysfunction drug, Cialis.
Its other acquisitions include Hypnion, Inc., CoLucid Pharmaceuticals added Reyvow for acute migraine, Loxo Oncology and Dermira. Lilly has collaboration agreements with several companies including Incyte, Boehringer Ingelheim and Innovent Biologics among others.
Conclusion And Risk Management
One way to set a stop loss for an iron condor is based on the premium received. In this case, we received $285, so we could set a stop loss equal to the premium received, or a loss of around $285.
Another way to manage the trade is to set a point on the chart where the trade will be adjusted or closed. That could be around $590 on the downside and $670 on the upside.
Please remember that options are risky, and investors can lose 100% of their investment.
This article is for education purposes only and not a trade recommendation. Remember to always do your own due diligence and consult your financial advisor before making any investment decisions.
On the date of publication, Gavin McMaster did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
