Even though Amgen, Inc. (NASDAQ:AMGN) stock has one of the best-performing charts I’ve seen, it doesn’t get the respect it deserves. From a valuation perspective, it sells at a sizable discount to its competitors. Its price-earnings ratio runs at least 40% cheaper than Johnson & Johnson (NYSE:JNJ), Pfizer Inc. (NYSE:PFE), Merck & Co., Inc. (NYSE:MRK) or Celgene Corporation (NASDAQ:CELG).
The price action in AMGN stock is constructive up 24% year-to-date. But it’s not a standout among its industry. The iShares Nasdaq Biotechnology Index (ETF) (NASDAQ:IBB) is also up over 20% for the same period.
But even after this massive rally, I see upside potential in AMGN stock and I want to capture it for free. Biotechs are a hot target for investors. When the political landscape is free of rhetoric about taking down price-gougers, or M&A activity heats up, Wall Street goes on buying sprees in undervalued biotech stocks.
That’s what’s happening with AMGN, and I’m not just sitting on the sidelines — I’m going to profit as Amgen heads higher.
The recent acquisition by Gilead Sciences, Inc. (NASDAQ:GILD) rekindled the animal spirit in the sector. Wall Street now expects more buyout headlines, thereby placing a bid under the whole sector. This is highly supportive of my thesis in AMGN.
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Buying the AMGN shares outright and waiting for the rally is too much risk without any room for error. I am not one to do that especially not after such a massive rally. Instead, I will resort to the options, so I can structure a trade set up that allows me to build a buffer in case my thesis is wrong.
I will use this hidden relative value to finance the purchase of upside calls.
The Bullish Bet: Buy AMGN Dec $200/$210 call spread for $1.60. This is my maximum risk. Here I need AMGN to rally past my spread before time runs out in order to profit $8 per contract.
To mitigate my risk, I will add a second trance that would completely eliminate my out-of-pocket expense. Then I’d be long AMGN for free.
The Bank (Optional): Sell AMGN Jan $160 put and collect $2 to open. This is also a bullish trade that has an 85% theoretical chance that price will stay above my strike. Otherwise, I have to own the shares at that price.
Taking both sides results in a credit into my account. This means that I would get paid to be long AMGN stock. In fact, as long as the price stays above the puts I sold I am profitable already even if the stock stalls. Any premium I collect from selling my calls would be pure profit.
Selling puts means that I am willing and able to own the shares. This is a method I employ often when I see value and proven support levels. Indeed I come into this trade with profits in pockets from several such strategies this year like this example.
Since there are no guarantees when investing in the stock markets, I never bet more than I am willing to lose.
Learn how to generate income from options here. Nicolas Chahine is the managing director of SellSpreads.com. As of this writing, he did not hold a position in any of the aforementioned securities. You can follow him as @racernic on twitter and stocktwits.
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