Options Corner: Bullish Traders Eye Eli Lilly As Market Signals Hint At A Turnaround

While multinational pharmaceutical firm Eli Lilly and Company LLY represents one of the top drugmakers in the world, that status alone hasn't exempted its equity from underperformance. In the past 52 weeks, LLY stock finds itself down almost 16%. Since the beginning of this year, LLY has barely poked its head above parity. Nevertheless, the statistical winds may point to an eventual recovery which options traders could potentially exploit.

Fundamentally, in the post-pandemic era, sentiment toward Eli Lilly skyrocketed thanks to its weight-loss drug. In 2023, the U.S. Food and Drug Administration (FDA) approved the Zepbound (tirzepatide), the first prescription medication for treating moderate-to-severe obstructive sleep apnea (OSA) in adults with obesity. An injectable prescription medication that helps adults with other weight-related problems, Zepbound's clinical trials showed promising results.

Thanks to this early success, Eli Lilly and Novo Nordisk A/S NVO effectively formed a duopoly in the weight-loss market. While this reality contributed to a significant valuation surge, competition started to heat up last year. With major pharmaceuticals like Pfizer Inc. PFE and Roche Holding Ltd RHHBY announcing advancements in the development of obesity-fighting drugs, LLY stock entered into a frustrating consolidation channel.

Still, with the pharmaceutical giant incurring an extended period of red ink in the market, JPMorgan analyst Chris Schott is essentially making the case that Eli Lilly is undervalued. Specifically, prescriptions for Zepbound and Mounjaro (an injectable medicine for adults with type 2 diabetes) are running ahead of expectations in the second quarter. As such, this performance may allow the pharmaceutical to beat and raise guidance throughout 2025.

Even with the formulary change by CVS Health CVS putting around 200,000 patients at risk of losing access, Schott states that Eli Lilly's market share — which stands at about 70% to 75% of new patients — and strong momentum may help the company easily absorb the impact.

Statistical Backdrop Could Point To A Recovery In LLY Stock

Although the fundamental narrative of LLY stock is intriguing, it may also be a presuppositional leap. Essentially, the conclusion that LLY is undervalued is already embedded in the premise (that the market is not fully pricing in the good news for Eli Lilly).

If one thinks about it, it's an extraordinary claim. LLY stock routinely ranks among the most actively traded securities. That the market is somehow mispricing the pharmaceutical giant is an assertion that requires extraordinary evidence. In my opinion, if such evidence exists, it will likely materialize in the statistical realm as it's the arena that few (if any) analysts venture into.

A significant barrier to statistical analysis of the financial markets is the deployment of continuous scalar signals, such as share price or various valuation ratios. Because these signals are non-stationary, it's difficult (if not outright impossible) to extract meaningful insights based on the frequency of past analogs. Especially for highly traded securities like LLY stock, the measurement metrics constantly fluctuate.

To remedy this problem, we can impose stationarity by converting scalar signals into discrete states. For analyzing securities, converting share price into market breadth or sequences of accumulative and distributive sessions carries significant advantages. First, market breadth is essentially a representation of demand and demand is effectively binary. Second, clusters of binary codes can form distinct behavioral states, which can then serve as past analogs for extracting forward probabilities.

As an example, in the trailing two months, the price action of LLY stock can be interpreted as a "6-4-D" sequence: six up weeks, four down weeks, with a negative trajectory across the 10-week period. Admittedly, this process pancakes LLY's magnitude dynamism into a simple binary code. But the benefit is that this code can be easily segregated into distinct market profiles. From there, we can observe the likelihood of transition from one state to another.

With the above framework, we can identify that since January 2019, the 6-4-D sequence has materialized 38 times. From past analogs, we can also determine that in 68.42% of cases, the following week's price action results in upside, with a median return of 2.47%.

Accounting for the volatility on Monday, a realistic target over the next three weeks — assuming that the bulls gain and maintain control of the market — is just under the $800 level.

Playing The Odds With Eli Lilly

Based on the market intelligence above, bold speculators may consider the 785/790 bull call spread expiring Aug. 1. This transaction involves buying the $785 call and simultaneously selling the $790 call, for a net debit paid of $255 (the most that can be lost in the trade). Should LLY stock rise through the short strike price ($790) at expiration, the maximum reward is $245, a payout of 96%.

To be sure, the 780/790 bull spread expiring on the same day offers a payout of nearly 113%. However, the net debit required is $470, which puts significantly more capital at risk for only a modest increase in payout. Therefore, the 785/790 call spread is arguably more tempting.

Either way, both transactions require LLY stock to hit or exceed $790 on Aug. 1, which empirically appears to be a reasonable target. As a baseline, the chance that a long position in LLY will be profitable on any given week is quite high at 60.29%. However, the market's response to the 6-4-D sequence amplifies the odds in favor of the bullish speculator, thus incentivizing a debit-based strategy.

The opinions and views expressed in this content are those of the individual author and do not necessarily reflect the views of Benzinga. Benzinga is not responsible for the accuracy or reliability of any information provided herein. This content is for informational purposes only and should not be misconstrued as investment advice or a recommendation to buy or sell any security. Readers are asked not to rely on the opinions or information herein, and encouraged to do their own due diligence before making investing decisions.

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