I bought VRX April 7th 15 calls today.
As discussed, I like to see good technical setups along with attractive Implied Volatility levels. I think VRX has an additional kicker – a catalyst that should be coming soon that does not appear to be priced into the options.
Starting with the underlying chart, the market is weak and had selling on Friday that pushed us to a new 52-week low:
Chart from FreeStockCharts.com
This is a pretty ugly chart for bulls, to be honest. We had a wave of selling over the last week and this may not end. Traditionally, I’d say to play the long side here, we would want to just buy with a $12.90 stop level. Looking a little closer into a 15-minute chart, you can see how close this level is to current prices:
Chart from FreeStockCharts.com
So why am I interested in this name? Partially, we’ve seen a large wave of selling – the longs have capitulated and the shorts are in control. This is normally a bad thing, but if a bullish catalyst comes in in the form of a news release that changes the fundamentals, we could see aggressive buying due to short covering and new bulls getting involved. I see a catalyst coming that could do just that.
Valeant announced this morning that they had paid down $1.1 Billion of their debt. They still have a lot of debt, but in this press release, announced that they would be looking to restructure their remaining debt with an announcement in the first quarter. The first quarter ends in 25 days. If they can put together a favorable debt restructuring, then concerns over bankruptcy should subside. If not, then the company crashes and I may not be able to stop out of a long stock position anywhere near the current market level. Either way, I don’t want to be in stock on a long or short position – the equity may follow a fairly clean continuous move, but I see a decent chance that the market gaps and makes it hard to stop out of or into a position. Calls let me know my exact risk and also give leverage if we gap up.
An additional benefit of the options is that we may see a move below $12.90 before the announcement and that would take me out of my long position – if I stay with the call position, I can eliminate the concern of getting stopped out and then looking for a new entry that may not occur prior to their news announcement. In the end, the long stock trade is very difficult here, but options may work.
In order for calls to work, of course, they need to be priced attractively. So, let’s look at the historical volatility of VRX:
Chart from LiveVol
We are at the very low end of the Implied Volatility range in spite of trading at/near lows, seeing high realized volatility, and having a potential fundamental catalyst soon. All of this points to me that we can trade the options to get into this position.
I want to stay with options expiring in April since I don’t know when in March the announcement will come. I now looked at the Implied Volatility levels of each month:
Screenshot from LiveVol
April 7th is low Implied Volatility and captures our catalyst. I like the April 7th $15 calls as a way to get some leverage in case the new debt terms come out somewhat but not exceptionally bullish. If the details come out bearish, I expect to lose the premium I spent. If the details come out bullish, I can see a strong reason for us to push to or through the 100 Day Moving Average at ~16.50 – this would be a decent start to a short-covering, and then set us up to re-test recent highs at $17.55. In the bullish case, I expect to roll and reposition as opposed to just taking the money – the short covering rally could get very exciting in that circumstance, and so buying these calls for ~35 cents gives a nice 4-to-1 (on a move to the 100D MA) or better R&R while knowing exactly what my risk is. I don’t know what the results of that debt restructuring will be, but I like the R&R of these calls if they do restructure their debt favorably.
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