Washington Worries Trigger Bearish Merck Options Trades

Pharmaceutical stocks are tanking on Friday, and Merck & Co., Inc. MRK has been along for the ride. Merck shares are now down 8% in the past week, but at least one large option trader is betting there won’t be a Merck rebound anytime soon.

The Trades

On Friday morning, Benzinga Pro subscribers received three options alerts related to Merck.

At 10:17 a.m., a trader sold 500 call options with a $92.50 strike price expiring on June 19, 2020 at the bid price of $1.50. The trade represented an $75,000 bearish bet that Merck would be trading at or below $94 roughly a year from now.

Within a minutes time, likely the same trader sold an additional 1,250 of the same June 2020 Merck call options at the same $1.50 bid price via two additional trades.

After all was said and done, the trading action represented a total bearish bet of $225,000 on Merck.

Why It's Important

Even traders who stick exclusively to stocks often monitor option market activity closely for unusually large trades. Given the relative complexity of the options market, large options traders are typically considered to be more sophisticated than the average stock trader.

Many of these large options traders are wealthy individuals or institutions who may have unique information or theses related to the underlying stock.

Unfortunately, stock traders often use the options market to hedge against their larger stock positions, and there’s no surefire way to determine if an options trade is a standalone position or a hedge. In this case, given the trades were split up into three blocks, they could represent an institutional trader. Institutions often split up large option trades into smaller blocks to avoid drawing attention to their orders.

Limited Upside?

Assuming Friday’s trading action did not represent hedging, the trader seemed convinced Merck has no more than 19% upside over the next year, which isn’t a particularly bearish stance to take. Instead, the trader may simply be throwing in the towel on what was initially a speculative long-term rally thesis on Merck.

Pharma stocks took a hit on Friday thanks in large part to fears surrounding the approach U.S. President Donald Trump will take to lower prescription drug prices in coming months. The Trump administration abandoned its previous plan this week, which would have eliminated rebates from government-sponsored drug plans.

Under the current system, drug makers like Merck pay rebates to pharmacy benefit managers as payment for getting their drugs covered by Medicare’s Part D prescription plan. The Trump administration reportedly pulled its plan to eliminate these rebates due to concerns the plans might result in higher insurance premiums for seniors.

Now that the proposal has been scrapped, pharma investors are uncertain about what the future holds. One potential alternative plan the administration has mentioned in the past would be to create an “international pricing index” and force U.S. drug prices in-line with international prices. Merck CEO Ken Frazier has vocally opposed that plan and said it would likely be challenged in the courts if it were imposed.

The bearish trading on Friday is far from a suggestion that the Merck sell-off will continue. However, given the lack of political clarity for drug makers at the moment, a long-term rally in pharma stocks may be unlikely at this point.

Merck's stock traded around $79.53 per share at time of publication.

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