Healthcare Reform and Wellpoint (WLP): Options Strategies for the Bullish and Bearish
WellPoint Inc. (NYSE: WLP) has gained ground over the past several months after a sharp plunge from its early-2008 highs. With the healthcare legislation overhaul in its final stages in Washington, we’ve seen a bit of the “buy the rumor, sell the news” phenomenon … in reverse.
Following months, if not years, of pessimism and selling pressure in the healthcare and biotech sectors, investors have begun to return to these names, as the healthcare reform news out of Washington isn’t as dramatic as many were expecting. The increase in WLP is just one example.
This trend hasn’t gone unnoticed by Wall Street – BMO Capital Markets upgraded the stock this week to “outperform” (buy) from “market perform” (hold) and kept its 12-month price target at $74. BMO said that WLP stands to increase its “commercial profitability” thanks to a stabilizing member base and “lower-than-expected medical costs.” After closing at $64.69 on Tuesday, WLP is little changed late Wednesday at $64.54.
By trading WLP options in lieu of, or in addition to, the stock, investors can typically commit less capital (and can sometimes limit risk). Additionally, certain option strategies can benefit from “leverage,” meaning they may be able to yield better percentage returns than the corresponding stock trade.
Depending on whether you think healthcare companies are out of the woods and ready to rally (or if you think they are due for a pullback), there may be a workable options strategy. Below are two potential options strategies – not buy-sell-hold recommendations, just hypothetical examples of two trades – one bullish and one bearish-to-neutral.
*Option prices given as of Wednesday afternoon
Bullish Option Strategy: Cash-Secured Put
Traders who expect WellPoint to hold current levels (or who wouldn’t mind owning the shares at a discount) could consider selling a cash-secured put. The September 60 put is currently bid at $3.10. In order to execute this trade, one would sell the put, collect the credit of $3.10, and set aside $5,690 in cash for every put sold (60 minus $3.10 times 100). If WLP is holding above the 60 level at expiration, the put seller keeps this credit as profit.
If the stock falls below the strike, at or before expiration, the seller will likely be assigned and be required to buy the shares at an effective price of $56.90 (the strike price minus the premium collected). This is the reason a put seller “secures” the option with cash, in case he is obligated to buy the shares. At this point, the put seller assumes the risk/reward of a long stock position – unlimited to the upside, and significant to the downside (capped only by the zero level).
Bearish Option Strategy: Bear Call Spread
For those who expect WLP to hit resistance on its way higher, a longer-term bear call spread might be worth a look. The January 70/75 call spread can be sold for a net credit of about $1.75 (by selling the 70-strike call and buying the 75-strike call). The trader will keep 100% of this premium collected if WLP is trading below 70 at expiration. The maximum risk, which occurs if WLP is trading above $75, is limited to $3.25. Breakeven for this strategy is $71.75. If WLP is trading anywhere below this level when January options expire, the spread seller will retain some if not all of the maximum potential profit. This is essentially a neutral strategy as WLP shares do not have to drop for it to succeed; they just cannot rally more than about 7.5% in the next nine months.
Your Take?
Is the healthcare sector healthy again or do you doubt BMO Capital’s convictions? Let us know how you would trade WLP shares – or if you would stay on the sidelines entirely.
If you are new to options and still trying to get your feet wet, it’s helpful to start by trying your trades in a virtual trading account.
Photo Credit: leonieke
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