The pullback this week in
Teva Pharmaceutical Industries Limited (
is an opportunity to use the power of options for a
capital-preserving,stock substitution strategy. We're seeingbullish
divergence in Tevastock options ' implied volatility with less fear
on the latest price decline to new lows. This can mark a price
bottom, as the emotional selling extreme may have been exhausted
A failed test of the multi-year lows from 2009 and 2011 has
formed a bullish base over the past few weeks. The extreme low at
$35 a share from two years ago is a point the stock can lean on for
A range has been established between $42 a share and $38 since
May, which targets $46 on a breakout of the trading channel. That
level is near the stock's52-week high and the technical breakdown
point. As a rule, markets often return to breakouts to test
The $46 target is about 21% higher than current prices, but
traders who use a stock substitution strategy could make more than
four times that amount on a move to that level.
One major advantage of using longcall options rather than
buyingshares is putting up much less to control 100 shares --
that's the power ofleverage . But with all of the potential strike
andexpiration combinations, choosing anoption can be a daunting
Simplyput , you want to buy a high-probability option that has
enough time to be right, so there are two rules traders should
Rule One: Choose an option with 70%-plus
Delta is a measurement of how well an option follows the
movement in the underlying security. It is important to buy options
that pay off from a modest price move in the stock orETF
(exchange-tradedfund ) rather than those that only makemoney on the
infrequent price explosion.
Any trade has a 50/50 chance of success. Buyingin-the-money
options increases that probability. Delta also approximates the
odds that the optionwill bein the money at expiration. In-the-money
options are more expensive, but they're worth it, as your chances
of success are mathematically superior to buying cheap,
out-of-the-money options that rarely pay off.
For example, with Teva trading at about $38 at the time of this
writing, an in-the-money $30 strike call currently has $8 in real
orintrinsic value . The remainder of any premium is thetime 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
Time is an investor's greatestasset when you have completely
limited the exposure risks. Traders often do not buy enough time
for the trade to achieve profitable results. Nothing is more
frustrating than being right about a move only after the option has
I recommend the Teva Jan 2014 30 Calls at $8.50 or less.
A close below $35 in the stock on a weeklybasis or the loss of
half of the option premium would trigger an exit. If you do not use
a stop, the maximum loss is still limited to the $850 or less paid
per option contract. Theupside , on the other hand, is unlimited.
And the January 2014 options give thebull trend a year to
This trade breaks even at $38.50 a share ($30 strike plus $8.50
option premium). That is about 50 cents above Teva's current price.
If shares hit the upside breakout target of $46, then the options
would deliver a gain of almost 90%.
Action to Take -->
Buy Teva Jan 2014 30 Calls at $8.50 or less. Set stop-loss at
$4.25. Set initialprice target at $16 for a potential 88% gain in
This article originally appeared on ProfitableTrading.com:
Bullish Breakout in This Pharma Stock Could
Deliver 88% Profits