Eli Lilly was all the rage in the market this week with its bullish performance of the anti-obesity medication Mounjaro.
Pharma stocks that focus on the anti-obesity medication have been grabbing attention in recent weeks as they move through some upward targets. As noted in IBD, first-quarter sales of Mounjaro topped expectations. The drug is for diabetes, but Lilly is trying to turn Mounjaro into an obesity treatment, too.
The stock is also sitting in the buy zone of a solid cup-with-handle formation.
With a Composite Ratio of 89, Lilly stock is ranked second in the Medical-Diversified industry group, according to IBD Stock Checkup.
And with these new anti-obesity medications gaining traction, any fades in Lilly stock are likely to be bought. LLY also sits in IBD Leaderboard.
Lilly Trade Neutral To Bullish
The trade is a long call butterfly with extended duration expiring in September. That gives the chart a chance to fade and hold within a solid range.
This trade is a neutral to bullish position and anticipates the hold of price above 390 over the summer term.
- Buy to open 1 Lilly Sept. 15 monthly 390 call
- Sell to open 2 Lilly Sept. 15 monthly 400 calls
- Buy to open 1 Lilly Sept. 15 monthly 410 call
Total debit outlay is 0.38 per butterfly, and since this is a debit, this becomes our total risk for holding the position.
A potential high profit line for the Lilly stock options position is calculated in the following way:
The difference between the strikes of the long call spread ($390-$400=$10) minus the cost of the butterfly (0.38). The total is $9.62.
This trade is a neutral to bullish position and anticipates the stock holding above 390 over the summer term.
Understanding The Call Butterfly
This is a neutral to bullish strategy that uses four options contracts with the same expiration but three different strike prices:
- 1 with a higher strike price
- 2 with a midline strike price
- 1 with lower strike price
It is called a butterfly because of the fat middle (holding twice as many strikes) and the "wings" on either side.
Butterflies are very powerful trading instruments as when they are managed well, they reap high returns. They will work in areas of low volatility with a grinding about within a range for an extended period of time, or high volatility when sharp spiking that does not break through the middle of the butterfly strike will deliver the strongest results.
The market currently sits in a unique position with a low volatility reading VIX but underneath the volatility of volatility is beginning to rise. This can lead to whipsaw price action so spending a lot of money on premiums increases the risk profile.
As with every trade, if a trade is inexpensive there is a trade-off. Holding to expiration as the price continues to rise will likely eat into the total profit, so managing the trade is a little different to the other types of formations.
Trade Management
The biggest plus in our favor for this trade is how inexpensive it is and the opportunity for very high reward.
Identify the key chart levels.
The breakout level is 390. Our premise is that this chart might fade as it trades near new highs. So we want to give it time to pull back a bit and not affect the value of our option investment by much.
Scenarios For LLY Options Trade
What could happen:
The stock moves into the middle strike of 400 and it stays close to this number but not over it by expiration. In that case we make the full profit of $9.68 less commissions.
The stock moves to the highest strike we purchased and moves higher and we take a loss of the entire amount of 0.38 plus commissions.
The stock moves into 395. This will mark the ideal profit line as we move into the end of the summer — where the position will likely be worth somewhere between $1.7 and $2.55 — and we exit the trade with the profit line.
Check out IBD's new OptionsTrader app for options education, trade ideas and more! Download from the Apple App Store today.
If you feel bearish about the market, and anti-obesity medications in general, the put butterfly in the same month of expiration using the strikes of 330, 320 and 310 are going for a 0.10 debit.
I do not often hold a stop on my butterflies. If the chart ends up not moving, or begins to behave poorly, I will sell another short call spread at my strikes and create a positive event out of the trade, always with an eye on risk
It is for this reason that butterflies, though a bit more of a trading event, are well worth the learning event.
As with all trades, consider what you like about holding the position in the first place and consider your risk carefully.
Anne-Marie Baiynd is a 20-year veteran trader of stocks, options and futures and is the author of "The Trading Book: A Complete Solution to Mastering Technical Systems and Trading Psychology." She holds no positions in the investments she writes about for IBD. You can on Twitter and Stocktwits at @AnneMarieTrades
