Cramer Says It’s Time to Buy Teva Pharmaceutical (TEVA) on a Pullback

Pills Last week, during his infamous “Lighting Round” on CNBC, Jim Cramer opined on Teva Pharmaceutical Industries TEVA, saying it might be a candidate to buy on the dip given its recent pullback. The eccentric Mad Money host said that even with health care stocks in reversal mode, it could be time to start buying.

TEVA shares have been in a steep downtrend since late March, shedding 18% of its value since its May 23 peak. During this pullback, the stock has breached prior support at its 50-day and 200-day simple moving averages. Cramer is trying to call the bottom here, which can be a very tricky thing to do, especially amid broad-market volatility.

For investors who want to follow Cramer’s thesis but not with the straight-line downside exposure of a straight purchase of 100 shares, there are bullish option strategies that could be put to work. Additionally, those who disagree with Cramer (on TEVA or everything in general) could take advantage of a bearish option strategy that might capitalize on continued downside in the shares (or an implosion in implied volatility). Two hypothetical option strategies on TEVA – one neutral, one bearish – are described below. Remember these are merely examples, not recommendations. Consider your own risk/reward parameters and personal trading goals before executing any new trades.

*Prices given as of Friday’s close. TEVA ended the session at $53.31.

Bullish Option Strategy: Long Call

Compared to the $5,331 price tag for 100 shares, one January 52.50-strike long call (which represents 100 shares of stock) is priced at $5.30 per contract ($530 per lot). The maximum loss for a long call is capped at 100% of the premium paid, while gains are theoretically unlimited.

Although the call buyer can sell the call to close at any time between execution and expiration, breakeven at expiration on January 21 (2011) is $57.80, or the strike price plus the premium paid. This afternoon’’s free strategy webinar is a look into the risks and rewards of long calls. Sign up today on our events page.

Profit/Loss of TEVA long call

Bearish Option Strategy: Bear Put Spread

Investors who expect continued downside in TEVA shares could take advantage of inflated volatilities to sell a bear call spread. By shorting the September 57.5 call and buying the September 60 call, an investor collects a net credit of 59 cents. If TEVA is still trading below 57.5 at expiration, the investor keeps this credit (the maximum potential profit).

The maximum potential loss of $1.91 occurs if TEVA is trading above $60 at expiration. Breakeven for this spread is $58.09 at expiration; TEVA can be trading anywhere below this level on September 17 and the strategy will be profitable.