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McKesson Corp. (MCK) Trade Alert

By Jeff Brown on January 31, 2017

Action to Take:

Sell to Open the MCK March 17, 2017 $125 put

Buy to Open the MCK March 17, 2017 $120 put

For a net credit of $0.55 or more

Profit Potential:

Max capital at risk per spread: $445 ($500 – $55)

Return on capital at risk:  $55/($500 – $55) = 12.4%

Days to expiration: 44

Trade Thesis:

The health care sector, as shown below by the Health Care Select Sector SPDR ETF (XLV), experienced a steep downturn leading up to the elections last year. This was primarily driven by the uncertainty about the kinds of gross margins pharmaceutical companies would be able to generate in the U.S. market after the elections.

Since early November, the ETF has been putting in a series of higher lows, resulting in an upward trend line (shown by the red line). Earlier this month, XLV shot above its 200-day moving average and is now resting on its 50-day moving average.

This presents a good opportunity for a bull put spread, but not on the index itself. I’d like to protect our credit spread by staying away from some of the big pharma names that might be affected by government-led negotiations around pharmaceutical pricing.

The name that I like in the XLV index is McKesson Corp. (MCK). McKesson’s business is primarily built around the distribution of pharmaceuticals and medical supplies, therefore I don’t expect it to be adversely affected in the short term by any negotiations between the government and big pharma.

McKesson announced its earnings on January 25, and as you can see below (red circle) the stock pulled back on the news.  Results for the quarter were actually strong, but there was an indication of uncertainty about McKesson’s next fiscal year.

At these levels, McKesson is trading at very reasonable valuations, and I believe that the pullback is temporary. Our time frame is short as well, with only 44 days to expiration. We don’t have to worry about any earnings announcements either, since McKesson’s next announcement will be on May 3.

This allows us to put on a bull put spread in McKesson with our short strike at $125, which is around the bottom that we saw in McKesson in early November.

Action to Take:

Sell to Open the MCK March 17, 2017 $125 put

Buy to Open the MCK March 17, 2017 $120 put

For a net credit of $0.55 or more

Profit Potential:

Max capital at risk per spread: $445 ($500 – $55)

Return on capital at risk: $55/($500 – $55) = 12.4%

Days to expiration: 44

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