Even though political news, economic uncertainty and the tech industry continue to dominate headlines, there’s another group of stocks that have been in the frying pan and making their own splash – albeit not a pleasant one for them – of late.
The pharmaceutical industry is vast, global, heavily regulated, controversial and – most importantly – in the hot seat.
As political pressure continues to mount on drug prices, many players in the drug industry face thousands upon thousands of lawsuits over the ongoing devastation of the opioid epidemic. Many are comparing it to what Big Tobacco went through 20 years ago over the health risks of their own products.
Of course, Big Tobacco is still around. It is still making money. And Big Pharma will too. So, let’s take a look at what exactly is happening to drug companies in general… and how to trade specific ones right now.
This week, four major drug-related companies (including one drug maker) settled one opioid lawsuit in Ohio. Teva, AmerisourceBergen, Cardinal Health and McKesson agreed to pay $260 million to communities hit by the crisis. That was only a small fraction of the significance of the settlement.
Teva, the sole drug maker on trial here, also announced that its part of the settlement includes a $23 billion donation to opioid addiction treatment drugs.
Experts suspect that this continues to pave the way for those thousands of additional lawsuits to end in further billion-plus dollar settlements for Teva and the rest of the industry. Though, this may delay those a bit.
In any event, it’s important to note which companies are involved and at risk, as well as how suited they are to handle these large upcoming settlements.
We could fill pages and pages with names and liabilities. But for our trading purposes, we can see one company relatively in the clear.
Pfizer has long been a dominant name in the drug industry. And that hasn’t changed much throughout this crisis. It has steered relatively clear of the opioid crisis, with its own suite of products focused elsewhere… including Prevnar, Eliquis and of course Viagra.
So, while the looming liabilities continue to keep a black cloud over the rest of the industry, Pfizer should remain dry… on that front.
Instead, its main worry comes from D.C. The renewed and heightened focus of politicians (especially those running for reelection or higher office) on drug costs remain Pfizer’s chief worry. Though, it hasn’t sat idly by.
Pfizer’s Next Generation Plan
First, an update on what’s happening on Capitol Hill. The House is set to pass H.R. 3, ostensibly a drug-pricing bill. However, due to the historic gridlock and posturing in Washington, the bill has some issues.
H.R. 3, right from the start, was an attempt to bridge the wide gap between the parties on a common issue they both know constituents want addressed: drug prices. The problem, however, is how they are attempting, and failing to, meet in the middle.
Speaker Nancy Pelosi sought to keep the bill as watered down as possible to garner some Republican support. The progressives in her party are starting to throw a fit over the substance of the bill. Instead of adequately addressing the enormous price gouging going on, this bill offers very limited negotiation on the prices of only some drugs under only some circumstances.
Just this week, as the bill finally made its long way through several committees, progressives are pushing for amendments to strengthen the government’s power to negotiate. This alone could kill the bill. But even if it doesn’t, no vote will be held in the House until after its recess in November. Still, it will almost certainly get held up in the Senate and throughout the reconciliation process.
In short, this rather weak bill doesn’t scare Big Pharma… especially the likes of Pfizer. One reason is that the company has already shielded itself from the impact of price cuts on legacy brands. In a surprise move, Pfizer cut a deal to form a joint venture with Mylan back in July. The venture will create a new company sharing certain brands and older drugs.
Wall Street was initially skeptical of the deal, as it reduces Pfizer’s own primary portfolio of approved drugs. But that’s the plan. This allows the pharma giant to keep profits from its legacy portfolio (it will remain ownership of 57% of the new company), while trimming down its own size. It can get back to innovation and drug development for the next generation of drugs.
These are not likely going to be touched by any legislation for the foreseeable future. Meaning, Pfizer is well positioned to grow once again.
Considering the haircut in stock pricse following this announcement (which was mostly due to the divestiture of the portfolio rather than investors selling off PFE in general), we have a great trading opportunity.
As you can see, the selloff sent shares down from the mid-$40s all the way to around $34, where they hit a hard floor.
Now, after a few months of testing their new boundaries, Pfizer is set to move the needle again.
Next week, the company announces its third quarter earnings. More importantly, it’ll also give investors a look at what this joint venture means to the company going forward, as well as just what headwinds Pfizer might face.
As noted, those are much more limited than many in the industry. And investors should pick up on that. The company itself is already trading at a steep discount to many in its field, offering a longer-term reason to see some buyers come back in.
But again, take a look at that above chart. With prices entering this earning season right above their support, PFE has room to run on any positive result from its Q3 numbers or 2020 outlook. That’s where today’s profit potential comes in.
A Strategy For Short Term Bulls
A bull call spread is a type of options trade that involves buying a call option at a price near the current trading price of a stock set to rally in the short term… and then selling a second one with a higher strike price.
The income from the sold call helps offset some of the cost of the purchased one. Meaning, the overall cost and therefore risk in this strategy is reduced.
In exchange, some upside profit potential is capped. For smaller companies, or ones with huge surprise potential, that would potentially cut into returns. But for a massive company like Pfizer that can only surprise investors a little, that’s a fair exchange. After all, no matter what Pfizer says next week, shares are not likely to double overnight.
You can see how this risk-reward plays out here:
Source: The Options Industry Council
Let’s take a look at a specific bull call spread trade on PFE right now… ahead of earnings.
A Specific Trade on PFE
Right now, a trader can buy a December 20 $37 call on PFE for $0.66 per share and sell a December 20 $39 call for $0.16 per share for a net debit of just $0.50 per share. Since each is worth 100 shares of PFE, that’s a cost of $50 to enter this trade.
Now, that $50 is the only amount at risk for the two months this trade could remain live. The upside, however, could be far greater.
To find the maximum profit potential here, take the difference in strike prices ($39 – $37 = $2), and subtract the cost ($2 – $0.50 = $1.50). On 100 shares, that’s a potential gain of $150.
In other words, the trader risks just $50 for a potential gain of $150… or a return on risk of 300%. That’s a chance to turn every $1 into $4 if Pfizer is able to meet or beat analyst expectations as well as offer articulation on how this new joint venture could return the giant into a higher growth machine.
All of that is likely considering the vast political and economic situation surrounding the company’s industry. Investors might just find a needle in the haystack this earnings season, from one of the industry’s top companies. And traders can immediately take advantage.