BOTHELL, Wash. ( TheStreet) -- Shares of Sarepta Therapeutics (SRPT) have soared on positive data for the company's Duchenne's muscular dystrophy (DMD) drug candidate eteplirsen. In one day, Sarepta shareholders realized approximately 300% overnight gains on their positions.
After a big move in small-cap biotech, it's often smart to hedge a position even if further upside is expected. The best hedge, of course, is to simply sell your position and move on. For bullish holders seeking further upside -- but also wanting to sleep at night -- there are ways to protect profits through options.
Sell Stock, Buy Calls: One approach is to simply sell your stock and roll into In-the-Money Calls. Ignoring tax implications on your stock position, this approach is often a good strategy as it provides a hedge (the cost of the Call is your maximum risk) while maintaining upside exposure.
To execute this approach you first need to define your time horizon, i.e. how long do you want to maintain this exposure? Let's say you wish to hold for one more month. In this scenario, for example, you would sell your shares at the current price of $32 and buy the NOV 30.0 strike Calls for $5.00. In this trade, assuming you swapped 1,000 shares for 10 Call options, your maximum risk is $5,000. So if the shares tanked back down to $10 (for example only!), rather than losing $22,000 from your un-hedged long shares, your loss would be $5,000.This hedged option trade does have a cost: Sarepta shares need to increase to $35 to break even. You can reduce this cost further (but also cap upside) by selling NOV 40.0 strike Calls for $1.60 against the 30.0 strike Calls, thus reducing the total cost (and risk) to $3.40 per spread and capping upside above $40. Keep Stock, Buy Puts: If you don't wish to sell your Sarepta shares, you can always buy Puts. Again, defining your time frame is important as constantly hedging up your position can get expensive, especially with this high IV name. Assuming a one-month timeframe, you can buy the NOV 32.0 strike Puts for $4.80. As with the Calls, this is a defined risk position -- your stock is protected below $32 less the cost of the hedge (the Puts) and upside exposure is maintained after the cost of the Puts is covered. The stock needs to climb above around $36.50 to breakeven on the trade. As with the Call position, a lower cost (albeit higher risk) alternative is to buy a Put spread. This can be accomplished by selling, for example, the NOV 25.0 strike Puts for $1.20 against the purchased NOV 32.0 strike Puts. This results in a lower cost of $3.60 and provides a similar hedge until $25. Below this level, your shares are fully exposed to downside risk. Pelz has no position in Sarepta Therapeutics. To learn more about using options to trade biotech stocks, check out Tony Pelz's book, The Biotech Trader Handbook or subscribe to Chimera Research Group.
Select the service that is right for you!COMPARE ALL SERVICES
Jim Cramer and Stephanie Link actively manage a real portfolio and reveal their money management tactics while giving advanced notice before every trade.
- $2.5+ million portfolio
- Large-cap and dividend focus
- Intraday trade alerts from Cramer
- Weekly roundups
Access the tool that DOMINATES the Russell 2000 and the S&P 500.
- Buy, hold, or sell recommendations for over 4,300 stocks
- Unlimited research reports on your favorite stocks
- A custom stock screener
- Upgrade/downgrade alerts
Jim Cramer's protege, David Peltier, identifies the best of breed dividend stocks that will pay a reliable AND significant income stream.
- Diversified model portfolio of dividend stocks
- Alerts when market news affect the portfolio
- Bi-weekly updates with exact steps to take - BUY, HOLD, SELL
All of Real Money, plus 15 more of Wall Street's sharpest minds delivering actionable trading ideas, a comprehensive look at the market, and fundamental and technical analysis.
- Real Money + Doug Kass Plus 15 more Wall Street Pros
- Intraday commentary & news
- Ultra-actionable trading ideas
Our options trading pros provide daily market commentary and over 100 monthly option trading ideas and strategies to help you become a well-seasoned trader.
- 100+ monthly options trading ideas
- Actionable options commentary & news
- Real-time trading community
- Options TV