Monday, February 28, 2011

Trade of the Day: Forest Laboratories, Inc. January '12 bull risk reversal

The Trade
A trader bought 4,245 Jan '12 $40 calls at $0.80 and sold 4,245 Jan '12 $25 puts at $0.70 for a net debit of $0.10 or $42,450.

As you can see from the graph above, the spread is bullish. In this spread, the long calls are partially financed by the short puts. The maximum risk is being put the stock if the underlying is below $25 at expiration. The maximum profit potential at expiration is unlimited since we are long the $40 calls. The break even underlying price at expiration is $40.10.

The line shown in the chart above is the underlying break even price at expiration. Thee 52-week range for FRX is a low of $24.17 and a high of $34.59. Therefore, the underlying must make new highs for this spread to be profitable.

Forest Laboratories, Inc. and its subsidiaries develop, manufacture and sell branded forms of ethical drug products. On February 22, 2011, FRX agreed to buy Clinical Data Inc. (CLDA) for at least $1.2 billion, betting that Clinical Data's newly approved antidepressant Viibryd can help offset the loss of major products in coming years. FRX announced that the deal may not be profitable until 2014 as it invests in marketing Viibryd. FRX anounced today that they may receive approval this week for its drug, Daxas.

FRX traded 15,078 contracts today vs. an average volume of 1,167.

According to Google Finance, FRX has a lower P/E ratio and Price-to-sales ratio then drug industry giants Pfizer and johnson & Johnson.

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