Options Trade of the Day: Collaring Novartis AG


Shares of pharmaceuticals concern Novartis AG ( NVS ) have fallen more than 10% in 2010, but the stock has settled into a steady trading range between $47.50 and $49.50 per share. Despite the problematic price action, analysts are still calling for a rebound in the equity, with Zacks reporting that eight of the nine brokerage firms following NVS rate the shares a "buy" or better. Digging through today's options activity, I uncovered a trade that makes me believe that at least one investor has jumped on the bullish NVS bandwagon.

Specifically, the stock has seen considerable activity at its October 45 put and October 55 call. The trader apparently sold 11,000 October 55 calls for the bid price of $0.45, and bought an equal number of October 45 puts for the ask price of $1.25. Given this information, it would appear that we are looking at either a bullish collar (most likely), or an extremely bearish debit spread on NVS.

NVS October 55 call and 45 put volume details

For the uninitiated, a collar is an options trade established by simultaneously buying a protective put and writing a covered call on a stock already in the trader's portfolio. However, while the premium received from the sold call will help to offset the cost of the put (or even exceed it), the written call will also cap the investor's upside in the wake of an extended rally.

NVS collar details

Assuming that the strategy is indeed a collar on an existing long NVS position, the trader has set his stop-loss at $45 per share, and his target profit at $55 per share. Furthermore, he has given NVS until October expiration to hit either level. Depending on when the long NVS stock position was entered, the trader can limit his losses to practically nothing, or a specific percentage. For example, if the trader purchased NVS shares at the same time as the collar position, his downside loss would be at about 7.9%, while his gains would be capped at about 12.6% (nearly doubling his potential losses).

On the other hand, if the trader does not own NVS shares, the options strategy becomes an extremely bearish debit spread, with unlimited upside exposure due to the sold out-of-the-money call. With the October put bought for $1.25 and the October call sold for $0.45, the trader would need NVS to fall to $44.20 per share, a plunge of nearly 9.5%, in order to reach breakeven.

Looking at NVS from a technical perspective leads me to believe that the collar strategy is the most likely. As mentioned above, the shares are trading between support and resistance levels. What's more, NVS appears to be in the process of rebounding from short-term support near $48 per share, breaking out above resistance at $49 per share in the process. A breach of the $48 area could send NVS down to test its next potential area of technical support, near $45 per share, which is home to the purchased October 45 put. A buy-and-hold stock trader may view a trade below this area as a signal to cut his losses and exit the trade.

Meanwhile, $55 has been an area of technical resistance for NVS, capping the shares for most of February and March. Using the same logic as above, a rally into this area could be seen as a reason to take profits on a long stock position. As such, it would make sense to sell a call at this level to set an exit point for the trade.

NVS daily chart

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This article appears in: Investing , Options

Referenced Stocks: NVS

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