Concerns of weight loss, weight management and Type 1 diabetes are fueling the rise of our choice for this week's option position in Novo Nordisk. This column looks at a diagonal spread trade in NVO stock.
Thursday's IBD Stock Of The Day, Novo Nordisk rebounded as traders continued to slowly rotate out of tech leaders and into other sectors. The leadership of the "Magnificent Seven" shows some profit taking into the end of the month.
Plus, the Nasdaq completes its rebalance to show new percentages on Monday. This bodes well for price action in other sectors to hold.
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Novo Nordisk: Leader In The Ethical Drug Space
Novo Nordisk, the Danish developer of primarily antidiabetic drugs, has also been making waves in the weight loss industry. Consider using these tools to identify the best stocks to trade as the anchor points for your decisions. In fact, these tools may lead you to market leaders such as Novo Nordisk stock.
The group leadership rank for NVO is No. 1 with a Composite Rating of 97, according to IBD Stock Checkup. NVO sits in front of fellow pharmaceutical giants Novartis and Sanofi.
I am seeing a little profit taking in the leadership that has been fueling the stock market. Therefore, I expect prices to chop around in a range until traders get more clarity at the end of the month for the July 25-26 Federal Reserve meeting on interest rates. Using option configurations that allow participation of an uptrend with controlled downside remains an anchor for choosing the structure of an option trade.
This strategy also makes sense in a market that continues to hold its upward trend.
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Setting Up A Diagonal Calendar Spread
As we look at the option toolbox, the calendar spread allows for a steady price and a resumption of trend.
Here's how we could set up a diagonal spread trade in Novo Nordisk stock:
- Sell to open 1 NVO Aug. 18-expiration call with a 170 strike
- Buy to open 1 NVO Oct. 20 170 call
The calendar formation allows us to take advantage of sideways to slight upside motion in the near term, and then an rise in price in Novo Nordisk stock further in the year.
Because there is a month in between August and October, we can sell against the October option. This move creates even more of a revenue stream, making the cost of the trade diminish. We use this strategy to allow time decay to work in our favor.
Total debit spent here on Novo Nordisk stock comes out to $2.45 per spread, based on recent trading. This trade has a maximum risk of $2.45 plus commissions, irrespective of price movement. The break-even price (before commissions) is 172.45. Take the long call strike plus the cost of the spread, which lies just shy of a 172.97 buy point in a flat base, as noted in current IBD chart analysis.
The maximum return is potentially infinite. How? This could occur if the trader takes delivery of the stock at the strike, and Novo Nordisk stock continues to rise over time.
Defending The Trade In Novo Nordisk Stock
Stock hunting using fundamental and price strength within the IBD methodology is where I firmly plant myself under the backdrop of the current economic backdrop. I use technical analysis to find ideal buying opportunities in conjunction with the tools for strength seen on IBD.
As with many of the tech picks into the second half of the year, expectations of slowing motion drive the trade analysis. Any bursts of price could push us to the next leg up, but if the price action fades, our debit exposure is limited.
This spread in Novo Nordisk stock holds a short call in the front month (the month nearer in the future) and a long call in the forward month (the latter of the two months involved). The trade also caps the risk at $2.45 per set of contracts. The risk remains fixed. Why? The strength of the position lies in taking advantage of potential near-term weakness by using the proceeds of the call to fund future expansion in the trade.
Trade Management: Identify Key Chart Levels
Near-term price resistance in Novo Nordisk stock sits near 175. So, the spread formation will begin to erode into negative returns if Novo Nordisk stock moves above 175 as we get closer to expiration and the short call goes deeper into the money. Price support sits near 155. So, this anchor of prices needs to hold for the trade thesis to stay intact.
These trading scenarios could happen:
- Novo Nordisk stock moves higher in the front month of August, and I choose to use the October call to contain my risk by closing this position. If this happens early in the time line, we will leave with a profit.
- Stock moves lower. I lose 50% of the price of the premium of $2.45. Exit the trade using simple stop-loss rules.
- NVS stays within the region below 170 until after expiration in August. As a result, I own the October call at an excellent discount.
How To Lower Cost Of The Trade
In addition, if prices fade or hold steady, I can now sell another call option expiring in September in Novo Nordisk stock against the October 170 call which lowers my cost basis once more. As with all trades, consider what you like about holding the position in the first place and consider your risk carefully.
Be patient and allow price action to move around a range of your stops.
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 find her on Twitter and Stocktwits at @AnneMarieTrades
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