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Diagonal Call Celgene (CELG)

I opened a diagonal spread on Celgene (CELG).

music selection:  “A Stroke Of Luck” — Garbage

Celgene is an excellent candidate for a diagonal call.  It is stable with gushing cash flows and robust growth ahead of it due to a stocked full pipeline of promising drugs in Phase III trials.  I’ll leave breaking down the financials and valuation strengths to the Seeking Alpha types.  But I’ll also note there is a lot of meat on this tasty looking bone.  The diagonal call allows me to get leveraged exposure to that upside while earning an acceptable return on the deployed cash while I wait.  It also lowers risk as I have less capital deployed than on a simple written put or covered call strategy.

The diagonal call strategy is a spread composed of a long dated long call purchased deep in the money and a near dated short call sold somewhat out of the money to capture leveraged premium while leaving room for leveraged upside price appreciation.  The short call can be rolled repeatedly for additional income and to expand upside price appreciation potential.

I bought CELG190118C00055000 for 78.90 a share.  Going as deep into the money as possible maximizes my leverage in terms of cash deployed while minimizing the time value on the option which is a drag on long term returns of the long call.  Since shares are trading for about 132 dollars right now, I have about 40% leveraged exposure to upward or downward movement in the price of the underlying.  That is the primary reason for opening the diagonal call.

Since the above call is deep in the money, I effectively control 100 shares of CELG.  Writing a call against such a position carries no more risk that writing a call while owning the shares outright. In fact, it carries lower risk because less capital has been put at risk.  In the event of a bankruptcy, for example,  My loss is 7,890 instead of 13,200.  The lowered effective basis also provides leverage to the covered call position.  About 40% in this instance, thus allowing a lizard to write out of the money calls and still earn a good return on invested capital.

I sold CELG170922C00139000 for 1.28 a share.  The trade will be in force for 39 days and yields 15.18% annualized.  At the same time, there is room for 5.22% upward price appreciation in the shares during the holding period.  With the provided leverage, this would be a 8.75% gain on invested capital.  The hope is to capture a small amount of this potential appreciation and roll up six weeks for now to continue capturing price appreciation with leverage.

You may be wondering what the catch is.  It is simply that the long call has about 1.83 in time value on it.  It is a certainty this $183 will decay to zero by expiry.  The beauty of the setup is 128 dollars of this time value will be recovered in a little under 6 weeks.  The trade should then be producing a net profit in terms of time value while still providing leverage on the upside.

Devour your prey raptors!

{ 3 comments… add one }
  • Luis August 15, 2017, 11:00 pm

    Interesting.

    I would like to change all my positions from covered calls to diagonal calls, but my actual situation working in the mornings makes me impossible to watch over and adjust when necessary.

    My worry is the short position when reaches ITM and is called, I think it would be better to roll before this happens, when ITM is reached slightly.

    Another worry is the ITM call long position when stock lowers heavily, I don’t know if close position or roll-up&down long call.

    Regards.

    • The Lizard King August 16, 2017, 2:01 am

      You usually write a diagonal short call somewhat out of the money on a near term expiry to make it unlikely to move ITM. But yes, you roll if you get ‘upside down’. If you get assigned short, you can either buy to close or exercise the long call to satisfy the obligation. For downward price action, it is best to keep a trailing stop loss on the long call to protect yourself.

  • Chintan @ Alpha Trading September 8, 2017, 8:26 am

    Managing Greek would have been a much better option too..

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