Volume Talks Wednesday: A Bullish Biotech Breakout Option Play

Today's breakout report is for Wednesday March 24, 2010. If this is your first time reading one of my breakout reports you'll want to read the section below, however if you are familiar with my daily breakout report you should skip ahead to the list of stocks.

To reiterate previous blog posts like this, the first thing I do is scan the list for familiar names, such as stocks I am quite familiar with or ones which have appeared on similar scans multiple times in the past week or two (most of these names are unfamiliar so it saves a lot of time). This indicates there may be some real momentum behind the stock, and that it could trade higher/lower in following sessions as well. Then (if and when any of the stocks I find are familiar to me), I make sure the stock has options available to trade, and then take a look at the chart(s) to see if I can structure a potential option trade. The list in this post includes 28 stocks which traded higher on heavier volume, and 19 stocks which traded lower on heavier volume Wednesday March 24, 2010. Many times I find an option strategy I plan on opening if I am convinced some money can be made.

The tables below show the company, ticker, per share % increase, and volume increase (% increased compared to 50 day average). The first table is a list of potential bullish stocks, the second table is a list of potential bearish stocks. For your convenience I have ranked both tables in order from greatest to least volume % change.

Out of the bullish list above, one stock which appeared Tuesday and multiple times in previous scans is Perrigo Company (PRGO). Before I get into any detail I will give a company summary from Google Finance below.

Perrigo Company is a global healthcare supplier that develops, manufactures and distributes over-the-counter and prescription pharmaceuticals, nutritional products, active pharmaceutical ingredients, and pharmaceutical and medical diagnostic products. The Company operates in three segments: Consumer Healthcare, Rx Pharmaceuticals and API. The Company has other category that consists of the Israel Pharmaceutical and Diagnostic Products. The Company operates through wholly owned subsidiaries. In the United States, its operations are conducted through L. Perrigo Company, Perrigo Company of South Carolina, Inc., Perrigo New York, Inc., Perrigo Holland, Inc. and Perrigo Florida, Inc. Outside the United States, its operations are conducted through Perrigo Israel Pharmaceuticals Ltd., Chemagis Ltd., Quimica y Farmacia S.A. de C.V., Laboratorios Diba, S.A., Wrafton Laboratories Limited, Brunel Pharma Limited and Galpharm Healthcare Ltd.

Perrigo announced they were to acquire PBM Holdings, a private label baby food maker, for $808 million and was upgraded shortly after Tuesday, this caused the stock to spike higher, and the bullish price action continued Wednesday. I certainly believe the momentum for this stock is to the upside and if I was to ride the momentum in the stock I would consider getting long on a slight pull back and set a tight trailing stop loss. However I am considering opening a bullish option strategy which I will outline in detail below.

Click chart to enlarge
Perrigo Option Strategy: I would like to see slight profit taking bringing this stock back down to earth before I get long, but if it happens to pull back I need to see it hold two days above the 54.20 level which it opened at on Tuesday following the bullish news. My ideal entry point would be around this level, but before entering I would need to see a bullish confirmation on the chart. The option strategy I am looking at structuring is a very simple one, and only requires the use of two option contracts and one expiration. I would look at purchasing April 55 strike call options and immediately selling April 60 call options against them (1 for 1). This strategy is currently in-the-money and using current data it is trading a slight discount to the shares which is not unusual for in-the-money vertical spreads. This position could currently be opened for a net debit of $265 per spread. Depending on where the stock trades from here will determine the premium/discount for this vertical call spread, but as of this data the spread is trading at a discount of 15 cents per share. As stated I would like to get into this stock after a slight pull back and a bullish confirmation after that, therefore if I do end up opening this strategy near my ideal entry point, I would surely be paying a premium to open this spread.

Profit & Loss: The maximum loss from the example outlined above is limited to $265 per vertical call spread and will occur if Shares of Perrigo trade and close at or below 55 per share by April options expiration. The gain from this strategy is limited to $235 (or 88.7%) per spread and will result if shares of Perrigo close at or above 60 per share at April options expiration. The break even price per share is 57.65 at April options expiration. If I enter into this trade I will be monitoring my position based on the chart, as I rarely wait until expiration to close or allow my position to get exercised. As always, I will be updating the status of this trade in future breakout reports.

This is a bullish strategy and should not be considered if you think the stock will sell off in the near future. However if you feel the stock could move higher in the near future, this strategy could yield a nice gain. To get a better understanding of stock options and different option strategies please check out my Simplified Stock Option Trading E-Books.

These are just examples and are not recommendations to buy or sell any security; if you're more bullish/bearish, you’ll want to adjust the strike price and expiration accordingly.

The reason option volumes have surged in the last five years is because they are a great way to hedge your portfolio as well as create income off of your shares (see chart here). Keep in mind when using this strategy it is essential that broker commissions are low enough to profit from the position.

Disclosure: No Positions