How to Trade a Cash-Secured Put on Cadence Pharmaceuticals (CADX)
10/23/2009 12:01 am EST
Turning back to the healthcare and biopharmaceutical sector, the ONN Idea Generating Platform (IGP) turned its focus on Cadence Pharmaceuticals, Inc. (CADX), which has descended of late to technical support around the $10 area. This acted as support during recent pullbacks and may again guard against notable short-term declines in the stock.
This cash-secured put strategy allows time decay to be the investor’s ally. As expiration approaches over the next four weeks, the put will lose time value. If and when it expires worthless, the premium collected is retained as profit. Alternatively, if the put moves in the money and is exercised, the investor can buy the shares at an effective discount.
CADX Cash-Secured Put Trade Details
At the time of this writing, CADX shares are trading at $10.30. Make adjustments accordingly based on the current price at the time you are reading this.
* Sell the CADX November 10 put (out-of-the-money) for $1.30 per contract (the bid price)
* Net credit of $1.30 ($130)
* For every contract, set aside $870 in cash: [(10-1.30) * 100]
Securing the sold put with cash means the capital is available to buy the shares if assigned. At this point, you’ll have purchased CADX shares at an effective price of $8.70, or 15.5% less than they are currently priced.
The maximum potential profit for this strategy is the premium collected, or $1.30 per contract– minus any commissions paid at the time of the trade’s execution. Remember, a cash-secured put that expires worthless will not require any commissions to exit the trade.
The maximum risk for this position is $8.70, or the strike price minus the premium collected. Theoretically, this risk is in play if the investor is forced to buy the stock and if CADX shares were then to decline all the way to zero. With this and all other cash-secured put strategies, the break even is also the strike price minus the premium collected, or $8.70 in this trade. CADX would need to drop the aforementioned 15.5% to breach this break-even point. Return on risk for this strategy is almost 15%.
CADX earnings are due on or around November 5. When the stock last reported, it fell about 8% the following day – still not a large enough move to take the stock below break even.
By the Staff at ONN.tv
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