How ObamaCare Could Lead to 100%-Plus Gains

Pharmaceuticals are getting attention with the Affordable Care Act ruling from the Supreme Court today.  For pharma companies that sell cheap, generic drugs the ruling does not matter — they’ll see continue demand. Now that the Affordable Care Act has been upheld, Teva Pharmeceuticals (NYSE :TEVA) is positioned to rebound with policy certainty moving business forward.        
 
After making new five year lows last September a higher low has formed a bullish base over the last few weeks.  The low extreme is a point to technically lean against for support.  
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A range had been established between $37 and $40 per share during the month of June.  The upside breakout did not see follow through buying yet and prices have recoiled into the sideways trade again.  A move above the recent highs at $41 targets $45 and the May breakdown origination point.
 
The pullback this week in TEVA is an opportunity to use the power of options for a capital preserving stock substitution strategy. The January 2013 option gives the trade over six months to develop.
 
The actual shares are inexpensive compared to some other stocks, but buying shares could tie up money that could be put to better use.  An In-The-Money option gives you the right to be long the shares from a lower strike price and costs much less than the stock itself.
 
Bullish divergence has also appeared in the options implied volatility. There’s been less fear during recent price declines.  This can mark a bottom as the emotional selling extremes may have been exhausted.
 
 
Shares of TEVA have dropped 38%-plus from the two year peak at $57.  A halfway bounce from those highs to recent lows conservatively targets $47 and a rally above Jan-May resistance.
 
The Options Way: Unlimited Upside Potential with Limited Risk. 
 
A TEVA long call option can provide the staying power in a potential larger trend extension.  More importantly, the maximum risk is the premium paid.

One major advantage of using long options instead of buying or selling shares is putting up much less money to control 100 shares — that’s the power of leverage.
 
Choosing an option can sometimes be a daunting task with all of the choices and expirations.  Simply put, traders want to buy a high probability option that has enough time to be right.
 
The option strike price is the level at which you have the right to buy without any obligation to do so.  In reality, you rarely convert the option into shares. Simply sell the option you bought to exit the trade for a gain or loss.   
 
There are two rules options traders need to follow to be successful.
 
Rule One:  Choose an option with 70%-plus probability.  The Delta is a measurement of how well the option reacts to movement in the underlying security. It is also important to buy options that payoff from only a modest price move. 
 
There is no need to ONLY make money on the all but infrequent long shot price explosions. Good options can profit from only modest directional moves.
 
Any trade has a fifty/fifty chance of success.  Buying options ITM options increase that probability.  That Delta also approximates the odds that the option will be In The Money at expiration. 
 
Buying better options are more expensive, but they are worth it — the chances of success are mathematically superior to buying cheap, long shot Out Of The Money lottery tickets that rarely ever pay off.   
  
With TEVA trading at $39.50, for example, an In The Money $35 strike option currently has $4.50 in real or intrinsic value.  The remainder of any premium is the time value of the option.
 
Rule Two: Buy more time until expiration than you may need — at least three to six months for the trade to develop.  Time is an investor’s greatest asset when you have completely limited the exposure risks.  
 
Traders often buy too little time for the trade to develop.  Nothing is more frustrating than being right but only after the option has expired premature to the market move.
 
Trade Setup: I recommend the January 2013 TEVA $35 Call at $6.00 or less. A close in the stock below $35 on a weekly basis or the loss of half of the option premium would trigger an exit. 
 
An option play also has staying power with the ability to ride through Ups and Downs that would force most stock traders out of the position. The option also behaves much like the underlying stock with a much less money tied up in the investment.  The January 2013 option has nearly seven months to develop.
 
The maximum loss is limited to the $600 or less paid per option contract. The upside, on the other hand, is unlimited. 
 
The TEVA option trade breaks even at $41.00 at expiration ($35 strike plus $6 option premium). That is just a little more than a dollar above TEVA’s current price. If shares hit the higher $47 price target above, the option investment would DOUBLE for 100% plus return on investment.