How much leverage can options produce? Keep reading to find out.
On Friday, an investor crafted a three-part strategy in Mylan (MYL) that involved selling two contracts to buy another. The result was a position with the potential for massive percentage gains but also significant downside risk. Here are the components:
- 6,700 January 40 calls were purchased for $2.19.
- 6,700 January 50 calls were sold for $0.25.
- 6,700 January 35 puts were sold for $1.89.
The net cost was just $0.05. ($2.19 – $0.25 – $1.89.) The position will be worth $10 if MYL closes at or above $50 on expiration in early 2019. That would be profit of 19,900 percent from a 30 percent rally in the underlying.
How on earth can they get that leverage? First, a vertical spread in the calls can capitalize on a move between two strikes — in this case $40 and $50.
But the real juice comes from short puts that generated virtually enough income to offset the entire cost of the bullish spread. Of course, those open the door to big losses below $35. See our Knowledge Center more.
The trader may have selected that level because MYL bounced just above $35 in May and July. That could make chart watchers view it as support.
The stock ended the shares up 5.28 percent to $38.45. It’s drifted aimlessly for more than a year but tried to rally on June 4 after the Food and Drug Administration approved its knock-off version of Amgen’s (AMGN) Neulasta bone-marrow drug. Strong earnings has also caused sentiment to shift in favor of the broader health-care sector over the last month.
In conclusion, someone combined technical chart levels with options strategies in hope of riding a move in MYL by early next year.
