The short-term option
08/24/18

When a stock leaps 30% in a day and then follows up with a 10% jump the next day, you can be sure of two things: There’s a juicy piece of news, and options prices (at least calls) are going to get pumped up.

Such was the case the past couple of days for cancer diagnostics company Exact Sciences (EXAS), which closed $15.27 higher on Tuesday and tacked on another $8.40 intraday yesterday for a two-day, 44% gain—and a record high price of $73.72:

Exact Sciences (EXAS), 4/2/17–8/23/18. Exact Sciences (EXAS) daily price chart. The Pfizer bump.

Source: OptionsHouse

The news: EXAS was partnering with Pfizer (PFE) to promote (and share marketing expenses for) Cologuard, Exact Sciences’ flagship colorectal cancer diagnostic test that has already been doing quite well, with sales up 78% (to more than $100 million) in the most recent quarter.1

The issue for traders is not whether the partnership will be a win for either or both companies in the long-term, but whether this week’s move presents a short-term opportunity. A few things traders may be looking at:

1. This was an exceptionally big price move, although not entirely unprecedented. EXAS has had +30% or larger days followed +10% or larger intraday gains seven other times since 2001. That’s not a lot of history to go on, but it’s worth noting that after one week the stock was lower in six of the seven instances, after two weeks it was lower five out of the seven, and after three weeks, it was lower six of seven times.2

2. Did call options prices increase? They sure did. Around noon ET yesterday, for example, the $75 call expiring on September 14 (in three weeks) was around $1.95, up $1.67 from the day before. That’s quite a bump—a bigger percentage gain than the stock’s move.

3. By approximately 2 p.m. ET, EXAS had pared its intraday gain by more than $6 and was trading below $68—still a more-than-healthy +3.4% on the day, but possibly an indication that some traders were willing to take profits on the up move sooner rather than later.

Prior to its big jump, EXAS had been struggling for the better part of three weeks to rebound from its post-earnings drop on August 2 (it missed revenue estimates), which was part of a larger decline from its mid-June high. Given the dramatic increase in call options prices, a trader who expected the stock to cool its jets in the near term—either move sideways or give back some portion of the two-day rally-- may choose to sell calls instead of risk the direct exposure of a short position in the stock.

Exact Sciences (EXAS): Short $75 September 14 call option. Collecting premium

Source: OptionsHouse

For example, the chart above shows the profit/loss profile for shorting the September 14 $75 call at $1.95: The position would lose money if the stock price climbed above the $75 stock price by expiration (but this would probably not result in being assigned shares, unless the stock traded well above that level), while the trader would get to keep all that premium as long the stock continued to trade anywhere below that level.

Long-term investing is a marathon. Trading is more like sprinting, and stocks, like people, often get temporarily winded after a making a dash.

 

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1 Reuters. Exact Sciences surges after marketing deal with Pfizer for cancer test. 8/22/18.

2 Supporting document available upon request.