Oversold in May... But Don't Go Way
Here's why I am buying the pullback in this cheap pharma stock. Plus, my stock pick of the year soars on a favorable ruling.
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First, just a bit housekeeping before I get to my latest covered call trade idea.
Acadia Pharmaceuticals ACAD popped 26% on Friday on a favorable patent ruling. I have profiled ACAD several times this year and it began 2025 as my "stock pick of the year."
I started to accumulate a large position in Acadia early in the fourth quarter of last year after the stock got clearly oversold after the company lowered full-year guidance for recently launched Daybue. Most of my holdings in this mid-cap biopharma concern were within covered call positions. This means I left some profits on the table. However, ACAD was one of the largest positions in my portfolio and I am happy to have a mid-to-high teens return locked in on this name. Especially with the additional downside risk mitigation covered call trades provide. I am also perfectly content to hit consistent singles in an overbought market.
Oversold and Undervalued
Today, we are going to look at another drug-related concern that looks like it has also gotten oversold here in the month of May. Halozyme Therapeutics HALO is a stock I have executed numerous, successful several covered call trades on over the years. The shares seem to get hit with a significant downdraft once or twice every year, and the equity has consistently done a good job then rebounding off those lower entry points.
Hamozyme has a somewhat unique business model in the pharmaceutical industry. The company enhances the delivery of others' approved injectable drugs via an advantageous subcutaneous formulation using its patented and proprietary ENHANZE drug delivery platform. This significantly improves these drugs infusion times and Halozyme collects milestone payouts and royalties on commercialized sales of the upgraded products.
The stock plunged on May 13 after surprising new new guidance from the Centers for Medicare & Medicaid Services indicating a faster-than-expected timeline for the company’s combination drug products to face Medicare price negotiations. The stock did bounce back some on Friday but is still down around 25% from when this news came out and triggered analyst downgrades.
It is important to note a few things here about the news out of the CMS. First, this is just draft guidance right now, nothing has been set in stone. Second, it would impact drug sale prices to Medicare but does not apply outside of government programs. This also should not impact sales or earnings for several years.
What's more, Halozyme could alter its business model to work earlier with major drug makers to have an improved drug on the market following the approval of the original compounds. This would increase the number of patentable years the enhanced product would have on the market even if the CMS follows through with these proposed new rules.
With the pullback, the shares now trade at just under 10 times forward earnings estimates. That's cheap, in our view, given the company should book sales growth around 20% annually for at least 2025 and 2026. Halozyme just raised 2025 sales guidance early in May following a big first-quarter beat. Management also announced a new $250 million stock buyback authorization. The stock does not pay a dividend but based on the last quarter’s free cash flow run rate, the shares have an approximate 10% free cash flow yield.
All in all, HALO seems cheap here, and I can make it cheaper still and garner substantial downside protection with the following covered call trade.
Option Strategy
This is how one can initiate a holding in HALO with a covered call order. As a reminder, covered call orders involve buying an equity and simultaneously selling just out of the money call strikes against the new position.
Using the December $45 call strikes, fashion a covered call order with a net debit in the $40.40 to $40.60 a share range (net stock price - option premium).
This strategy provides downside protection of 22% with upside potential of 11% even if this equity trades down nearly 15% over the option duration. For those that want less downside protection in return fir higher upside potential, use the December $50 call strikes for your covered call trade.
The options against the equity have good liquidity across the board.
At the time of publication, Jensen was long ACAD and HALO.
