Are Elan, Pfizer, Lilly and J&J Buys After a Failed Drug Test?

NEW YORK (TheStreet) -- If you're an Elan (ELN), Pfizer (PFE) or Johnson& Johnson (JNJ) investor, Monday's disappointing drug test result is always in the back of your mind but hopes are raised at the Phase 3 stage.ELN ChartELN data by YCharts

The three companies announced that bapineuzumab, Elan's drug for Alzheimer's disease, wasn't effective at slowing or halting the disease progression with people who have a mutation of the gene ApoE4. Eli Lilly ( LLY) has a similar drug in trials and its shares are trading lower Tuesday as well.

While the main larger group failed to demonstrate effectiveness, researchers intend to examine sub-groups for a positive response. (See Big Dividend Captures With Microsoft, Walgreens, Lilly, Target and Duke.)

Husseini Manji, the head of neuroscience research at Johnson & Johnson, reportedly stated, "We're optimistic that noncarriers are going to respond better" and people with the genetic mutation were "going to be a tougher nut to crack."

All three companies traded lower in aftermarket trading Monday. Elan, with the most on the line, was hit the hardest. Elan traded down over 13% before the completion of after-hours trading. TheStreet's Dan Fitzpatrick wrote a great article that includes Pfizer, Fitz Bits: Pfizer Looks Mighty. (You need a Real Money Pro account to read, but Fitzpatrick's analysis makes it worthwhile.)

Based on my experience with gap-downs following study results similar to Elan's (and Lilly's), the odds favor greater downside with Wednesday or Thursday, marking the short-term low. It's not quite time to wish for a quick gap fill, but ELN does have strong support near $10.50, LLY at $41.90, PFE at $23, and JNJ's support is at $67.90.

Friday or early next week will likely find bargain hunters picking up shares cheap to flip over. If Thursday appears to be closing below Wednesday's low, I may join with the bargain hunters for a quick hit-and-run weekend carryover. LLY Chart LLY data by YCharts

Bargain hunters and short-sellers covering positions could push the price up about 50% to 60% in relation to the gap-down price. Looking at the chart, I expect short-term resistance for Elan near $12.75, Pfizer at $24, Johnson& Johnson at $68.50. Round numbers often attract like a price magnet and repel, causing a bounce.

Expect a lot of Elan volume to trade near $11.50 a share Tuesday, but also be prepared for a closing under the opening price, and more than a 25% chance of a close under $11.50. PFE Chart PFE data by YCharts

If you are scrutinizing today's drop to signal a buying opportunity, you are likely going to find the end of the day Wednesday or Thursday better than Tuesday. There is no hurry buying the dip with ELN. Stocks dumping as a result of failed tests usually take a full month or two to recover, and only if no other disappointments are announced in the meantime.

Take your time and do your homework before allocating capital here. Look for the second break above $12.75 as the one that "sticks." JNJ Chart JNJ data by YCharts

Johnson & Johnson is so large and diverse that this speed bump will not likely stick in the memories of investors for long. Pfizer may take a breather from the rocket ride higher, but I expect bargain hunters to jump on board near $22.65 and lower, if it even makes it down that far.

What's the best play with these stocks? There should be a very attractive trade coming up Wednesday and or Thursday. Near the end of the day, if still trading lower, sell out of the money puts. Fear of continued losses tends to push portfolio insurance prices up dramatically, while at the same time, the stock should bottom.

It's not one to get greedy with. Hold on for a few days and as the implied volatility falls (hopefully with a nice dead cat bounce) exit out with a quick hit and run for profits.

Otherwise, for longer-term investors, the best play is to wait until we are closer to the next earnings release for an entry.

At the time of publication the author did not hold a position in any stock mentioned.

This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.

More from Opinion

3 Warren Buffett Stock Picks That Could Be Perfect for Your Retirement Portfolio

3 Warren Buffett Stock Picks That Could Be Perfect for Your Retirement Portfolio

Wednesday Wrap-Up: GE and Facebook

Wednesday Wrap-Up: GE and Facebook

PayPal Strikes Again, Facebook, and AT&T -- 3 Tech Stories You Must Know

PayPal Strikes Again, Facebook, and AT&T -- 3 Tech Stories You Must Know

How to Invest Like Warren Buffett

How to Invest Like Warren Buffett

50 Stocks That Could Be Shredded If a U.S. Trade War With China Ignites

50 Stocks That Could Be Shredded If a U.S. Trade War With China Ignites