Profiting from a Sideways Moving Celgene
The fundamentally robust Celgene(NASDAQ: CELG) entered 2013 at $81 and has rocketed up to a high of $102.29 already this year. On January 8th, The Biotechnology company gave a very rosy outlook out to 2017, and also announced positive trial results for some of its important experimental drugs. Soon afterwards, the strong bullish push continued with a slew of analyst upgrades. I believe Celgene will continued a bullish rise from here, but what other catalysts on the near horizon will send this stock to $110? Are there any other buyers left right now to propel this stock?
Looking at the Celgene Price chart on February 11th, I would have expected the dreaded profit taking pullback to send the price down to the 50 Moving Day Average at around $90 after the very sharp rise. However, the stock has formed a base trading around $100 and is trading in a channel. I am making an educated(Foolish?) guess that Celgene would trade around $100 for the rest of the week until February 15th. Using Options, I would structure a trade that would take advantage of range bound stocks.
Enter The Butterfly
The Options strategy that I chose was the Long Butterfly. Here is a quick review of this intermediate level options strategy. You can use either all Calls or all Puts to structure this trade of the same expiration Month(or Weekly Options if available). A long butterfly consists of multiple legs, where you would buy the outer "Wings" and sell the "Body"(centered between the Wings). I chose the Celgene February Puts (expiring on February 15th). The contract structure is a 1-2-1 ratio, where you would Buy 1 FEB 105 Put, Sell 2 FEB 100 Puts, and Buy 1 FEB 95 Put. Celgene was at $99.94 at the time of this trade.
The cost of the trade was $266, making my upside break-even $102.34, and my downside break-even $97.66 with 4 days to expiration. What this means for this Butterfly trade is that I need Celgene to stay between my upside and downside break-evens. The trade becomes profitable each day it stays in this range due to the time decay of the options that I am selling. If Celgene gapped up or down beyond the break-even prices, then I would lose the whole $266 by the expiration date on February 15th(Assuming I let the trade go all the way to expiration without closing it).
I would look to make a quick profit of 15% since I am only in the trade for 4 days maximum. If the trade would lose $80, then I would exit immediately as I didn't want to risk the whole pie of $266. As luck would have it, I would exit the trade on February 13th(2 days in the trade) for a profit of $44(before commissions) for a percentage gain of 16.5%. After only being in this trade 2 days and profiting, why not another Butterfly?
Let's Do this Again! A March Celgene Butterfly
Reviewing the chart and feeling confident that Celgene would continue in its range bound fashion centered around the $100 mark, I would open up another long butterfly for the March Expiration Options.
I opened a 2-4-2 March Call Butterfly to give me the ability to shave the position in half to take profits and reduce risks. I randomly chose Calls in this case as the stock was trading at $99. I could have easily used a Put Butterfly. Here is the position I opened on February 13th:
Buying 2 MAR 105 Celgene Calls
Selling 4 MAR 100 Celgene Calls
Buying 2 MAR 95 Celgene Calls
The cost of the trade was $290, with the upside break-even at $103.55, and the downside break-even was at $96.45. I would need Celgene to trade in this range until March 15th. If the stock closes for 2 days above or below my break-evens, then I would close the trade for a loss. This March Butterfly is still open.
There is still time in the March Expiration cycle to open up a Butterfly on Celgene if you think it will still trade in a range until March 15th, or for even a few days as the trade can become profitable with the accelerated time day of the options(Time Decay accelerates in the last 30 days of an Options life).
At first I thought the Butterfly was confusing as a beginning options trader. But after researching and studying it, the Butterfly is relatively simple. I believe that every investor should have an Options trading tool such as the Butterfly for those stocks that you instinctively know have range bound periods. Many stocks trade in a range between earnings periods and the Butterfly would be a great strategy to earn income for this situation.