SSI: Ultra – Recommendation #7 – JNJ Bull Put Spread
July 26, 2023
Ticker: JNJ
TRADE INSTRUCTIONS
Place the following trade for a CREDIT:
Sell to Open JNJ Sept 1 2023 $170 PUT and
Buy to Open JNJ Sept 1 2023 $160 PUT
Aim for a CREDIT of between $2.40 to $2.80 per contract. You will receive between $240 and $280 per contract traded in option premium as income into your account.
This is how the trade looks on Fidelity’s platform but should appear similar regardless of which brokerage you are using.
INVESTMENT RECAP
JNJ Current Price: $172.72
Stock Price Target: Above $170
Upside: +$240
Downside: -$760
This investment, if successful, will return a maximum of ~32% of our capital at risk.
If unsuccessful, we will lose a maximum of ~$760, if the JNJ is below $160 on September 1st, and we have not decided to close the trade previously.
Our breakeven is ~$167.60, which is ~3% below the current level of the JNJ today.
TRADE PROFILE
For a more in-depth discussion (or just a refresher) on each of these ratings, please visit the Trade Ratings Guide page here.
DETAILS
A “bull put spread” as its name suggests, is a strategy that employs puts to express a bullish outlook on a stock. Option traders typically use this strategy when they believe that a stock’s price will shortly be moving upward or, at the very least, not go below a certain price prior to the expiration date.
The strategy consists of selling a put with a higher strike price that’s close to the current price of the stock and buying another put with a lower strike price and the same expiration date. The maximum gain is the credit premium you earn from the difference in prices of the two puts, and will be earned if the stock finishes above the strike price of the short put, the point at which both puts expire worthless.
Maximum loss in this trade occurs when/if the stock price finishes at or below the lower strike price, And, it is limited to the difference between the two strike prices multiplied by 100, and net of the premiums earned from the initial trade. So, in our JNJ trade, since the difference between the two put strikes, $170 and $160, is $10, our maximum loss or capital at risk is ($10 x 100) – $240 = $760.
I typically like to use it when a stock with strong fundamentals and/or a history of significant volatility, trades below its 200 DMA. One name that I’ve regularly used it on this year is TSLA, on which I’ve managed to close out 6 out of 7 trades for a profit.
Today, we plan on using this strategy to profit from to on an going special situation in pharma giant Johnson & Johnson (JNJ):
Here’s Rich with the fundamental thesis (in italix to differentiate between Rich and Bruce):
Johnson & Johnson (JNJ) is spinning off its consumer health care business, Kenvue (KVUE), through a share exchange.
The way the share exchange works is as follows.
JNJ shareholders can exchange their JNJ shares for shares of KVUE.
To incentivize the exchange, JNJ investors will receive $107.53 of value in KVUE shares for every $100 of value in JNJ shares.
Given this attractive opportunity, there is likely to be buying pressure for JNJ stock until August 18, the last day to participate in the exchange offer as investors buy JNJ stock to participate in the exchange.
As a result, we expect JNJ to be up – or at worst, flat – between now and August 18.
This is consistent with the stock price behavior of the “parent” during previous “exchange offers” that we have reviewed (15 transactions reviewed – average return for the parent during the exchange offer is +2.1%).
As shown in the data above, in 2/15 instances (13%), the parent declined significantly. If JNJ declines sharply, we will lose money.
In 1/15 instances (7%), the parent declined by 2.4%. If JNJ declines by ~3%, we expect to break even.
In 12/15 instances (80%), the parent stayed flat or appreciated. If JNJ stays flat or appreciates, we will be able to keep the entire net premium received as both put options will expire worthless.
Given this history, Bruce and I believe the risk-adjusted reward is favorable for this trade.
RISKS
Both investing and trading are about probabilities and individual risk tolerance. When we launched Ultra, we wanted to provide a spectrum of strategies and risk-return options for subscribers, trusting that, properly informed, they would choose to participate in strategies that met their own individual criteria.
So, just to be clear: this is the potentially riskiest trade that we have done in SSI: Ultra to-date. This should be quite evident in the trade’s Risk Rating of 2, which is just below the highest risk level that we can assign.
However, the risks in this trade are both well-defined and limited: we lose $100 for every dollar under $170 that JNJ’s stock price is on September 1st, with total losses capped at $1000 minus the total premiums we collect.
Thus, we are essentially risking $760 to make $240.
To try to limit our risk, we will put an internal stop-loss of $240, which we will hit if JNJ trades (roughly speaking) below $167. This increases the risk-reward to roughly 1:1, but… it is important to note that there can be no assurances that the stock price will trade in an orderly fashion, and you should be prepared to lose a maximum of $760 per contract prior to entering this trade.
Properly braced, good luck to everyone that chooses to participate in our JNJ bull put trade!
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