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Investing with options: 4 strategies for Novo Nordisk: cash secured puts, long calls, synthetic shares, and ZEBRA's
Koen Hoorelbeke
Investment and Options Strategist
Summary: Explore four innovative options strategies to capitalize on Novo Nordisk, including selling in-the-money cash secured puts, buying long calls, creating synthetic shares, and employing the 'Zebra' strategy, each tailored to benefit from the healthcare giant's current market dynamics and heightened volatility ahead of its earnings release
Investing with options - Novo Nordisk - 4 strategies for longer time-horizons
Introduction
Novo Nordisk, a global healthcare company specializing in diabetes care and other pharmaceutical areas, has been experiencing a substantial uptrend in its ADR listing on the NYSE. As the anticipation around its upcoming earnings release grows, so does the volatility, creating a unique and potentially profitable environment for options traders and investors.
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Capitalizing on the heightened premiums due to this elevated volatility, investors can explore various strategies tailored to benefit from Novo Nordisk's current market dynamics. This article will delve into four distinct investing strategies, each designed with a longer time-horizon in mind. Whether you are seeking to optimize your portfolio through selling in-the-money (ITM) cash secured puts or considering innovative approaches like synthetic shares and the "zebra" strategy, these techniques offer diverse avenues to harness Novo Nordisk's booming performance.
In this article, we'll explore four options strategies to 'invest' in Novo Nordisk for the long term. Each approach offers a unique risk and reward profile, catering to various investment objectives and risk tolerances. We will delve into the following strategies:
• Selling In-the-Money (ITM), cash secured puts
• Buying long calls
• Buying synthetic shares
• Buying a "Zebra" strategy
These 4 strategies are all for investors who believe that Novo Nordisk will go higher, who are bullish on NVO. Of course all these strategies can be adapted to work in the opposite way, to be bearish. We will not elaborate on the bearish versions, since this will make the article much too long. We (Saxo) are neither bullish or bearish on the stock, this article is used to illustrate how the techniques work, not to express our view on the stock itself!
Important note: the strategies and examples provided in this article are purely for educational purposes. They are intended to assist in shaping your thought process and should not be replicated or implemented without careful consideration. Every investor or trader must conduct their own due diligence and take into account their unique financial situation, risk tolerance, and investment objectives before making any decisions. Remember, investing in the stock market carries risk, and it's crucial to make informed decisions.
1) Cash secured put
Selling a cash secured put is actually not an "investment" strategy, but rather a way of acquiring stock with a "reduction". This strategy involves selling a put option on Novo Nordisk with a strike price that's currently in-the-money (ITM). Let's consider the specific example of the put option expiring on September 15th 2023, with a strike price of 190. With Novo Nordisk last traded at 188.93, this put is ITM.
Selling this put option would involve receiving an upfront premium of 8.50 per share, providing an immediate return on your capital. In addition, since this is a cash-secured put, you would set aside the necessary funds to buy 100 shares of Novo Nordisk at the strike price, if assigned.
Here's where the strategy becomes particularly interesting. If NVO's stock price remains above the strike price of 190 at expiration, the put option would expire worthless, and you would keep the entire premium as profit. However, if Novo Nordisk's price drops below 190, you would be obligated to purchase the shares at the strike price. But remember, you already received a premium of 8.50 per share, effectively reducing your purchase cost to 181.50 per share (190 strike - 8.50 premium). This results in acquiring Novo Nordisk's stock at a discount to its current trading price.
This approach serves two purposes: providing immediate income through the premium and potentially setting you up to acquire Novo Nordisk shares at a price lower than the current market rate. However, it's important to understand that selling an ITM put comes with the risk of being assigned before expiration, given that the option is already ITM. But for those bullish on Novo Nordisk over the long term, this might be seen as a win-win scenario: either keep the premium if the option expires worthless or acquire NVO shares at a discounted rate.
Some remarks:
- Make sure you have enough cash available on your account on the day of expiration. If you do not have enough cash at hand, the close-out procedure that Saxo has in place to protect you from going negative, will close your put-option (if the option is ITM), which is, in this case, exactly the opposite of what you're trying to achieve
- As you can see in the example above: the expiration date is not too far out. The goal is to acquire stock. The further you go with your expiration date, the longer you will have to wait before you are assigned (unless you get an early assignment, but that's unpredictable)
2) Buying long calls
Another investment strategy to consider for Novo Nordisk is purchasing a long call option. By doing so, you gain the right to buy Novo Nordisk shares at a fixed price (the strike price) within a certain timeframe. Consider the specific example of buying a long call with a strike price of 180, expiring on January 17th, 2025.
For this privilege, you pay an upfront premium (debit) of $37.50 per share, which equates to a total investment of $3,750 for one contract (remember, each options contract controls 100 shares). With Novo Nordisk currently trading at 188.88, this option is in-the-money, meaning that the strike price is less than the current stock price.
Buying a long call could potentially offer significant upside potential. If Novo Nordisk's stock price rises above the strike price plus the cost of the premium (in this case, 180 + 37.50 = 217.50), you'll start to see profits. The further Novo Nordisk's stock price climbs, the greater your profits could be.
However, it's crucial to remember the risk involved. The maximum risk in buying a long call option is the premium paid. If Novo Nordisk's stock price remains below the breakeven point 217.50 in this case) at expiration, the call option will expire worthless, and your entire investment (the premium paid) would be lost.
Buying a long call is an inherently bullish strategy, and is ideal for investors who are optimistic about Novo Nordisk's potential for price appreciation over the next 527 days. It allows you to control a large amount of stock for a fraction of the cost of owning it, but this comes with increased risk compared to owning the stock outright. Therefore, it's important to thoroughly evaluate your personal risk tolerance and financial situation before choosing this strategy.
3) Buying synthetic shares
An innovative way to "invest" in Novo Nordisk without actually owning the stock is through a synthetic share. A synthetic share is an options strategy that involves selling a put and buying a call at the same strike price. The result, in this example, is a position with a delta of approximately 1.0597, meaning it mimics owning the stock by moving almost dollar for dollar with the stock's price changes.
Consider the specific example where we sell a put and buy a call for Novo Nordisk with a strike price of 200, both expiring on January 17th, 2025. From today, August 10th, 2023, that gives us roughly 527 days until expiration.
The interesting aspect of this strategy is that it doesn't require a cash outlay. In fact, you receive a net credit of $80 for initiating this trade. However, it does necessitate margin, as selling a put always does. In this case, the margin requirement is €1,281.62 (margin requirements can vary according to the margin configuration of your account).
So, what are the risks and rewards of this strategy? The potential reward is theoretically unlimited, just like owning the stock. If Novo Nordisk's price rises, the synthetic share appreciates dollar for dollar with it due to the delta being near one. You also keep the initial credit received, providing a small buffer against potential losses.
The risk, however, is significant and undefined. If Novo Nordisk's price falls, your losses could be substantial, just like owning the stock. But remember, with the synthetic share, your loss could be even greater because you're obligated to buy the stock at the strike price of the put option (200 in this case), even if the market price drops well below that. This is the undefined risk inherent to selling a put.
The synthetic share strategy is for investors who are bullish on Novo Nordisk's long-term prospects and want to mimic stock ownership without the upfront capital required to buy the stock outright. In fact, this strategy could be particularly attractive to current Novo Nordisk stock owners. For example, an investor who owns 1000 shares of Novo Nordisk could convert 100 of them into synthetic shares. This move would not only maintain their exposure to the stock's performance but also free up cash for other investments, assuming they believe Novo Nordisk's price will continue to rise.
However, it's crucial to understand the potential for substantial losses and to be comfortable with this level of risk before considering this strategy. Investors should always evaluate their financial situation and risk tolerance before initiating such a strategy.
4) Buying a "Zebra" (Zero Extrinsic Back Ratio)
Another strategic way to gain exposure to Novo Nordisk's stock movement without directly owning the stock is by employing a zero extrinsic back ratio (ZEBRA). This options strategy involves buying two in-the-money (ITM) calls and selling one at-the-money (ATM) call. It is designed to mimic the behavior of owning the stock, with a delta around 1, providing near identical exposure to price changes.
Let's consider the example above. Novo Nordisk last traded at 188.88. To construct the ZEBRA, we sell one call with a strike of 180 and buy two calls with a strike of 145, both with an expiration of January 17th, 2025. This setup results in a position with a delta of 0.9987, indicating that the strategy will closely track Novo Nordisk's price movement. The strategy requires a net outlay of $86.70 per share (or $8,670 for a contract).
The potential reward of the ZEBRA strategy is similar to that of owning the stock: it profits if Novo Nordisk's price rises, providing virtually unlimited profit potential. And due to the delta being near one, the strategy should appreciate nearly dollar for dollar with any price increase in Novo Nordisk's stock.
However, unlike owning the stock, the ZEBRA strategy provides limited risk exposure. The maximum loss is the initial premium paid, which in this case is $86.70 per share. This risk profile is an advantage over buying the stock or synthetic share outright, where a substantial drop in the stock price could lead to much larger losses.
That being said, the ZEBRA strategy is best suited for investors who are bullish on Novo Nordisk's prospects and seek to mimic stock ownership without taking on the unlimited downside risk associated with it. As always, investors should consider their financial situation, risk tolerance, and investment objectives before initiating such a strategy.
Conclusion: Comparing Long Call, Synthetic Share, and ZEBRA Strategies
Choosing between the long call, synthetic share, and ZEBRA strategies depends on your investment goals, risk tolerance, and views on the future performance of Novo Nordisk's stock. Each of these strategies has its own set of advantages, disadvantages, and risk-return profiles. Therefore, the "best" strategy varies from one investor to another.
The long call strategy, with a delta of 0.6930, provides the benefit of limited risk and potentially unlimited reward. It offers a smaller exposure to changes in Novo Nordisk's stock price compared to the synthetic share and ZEBRA strategies, making it a more conservative choice. This strategy could be ideal for investors who anticipate a significant price increase in Novo Nordisk's stock but want to limit their risk exposure.
On the other hand, the synthetic share and ZEBRA strategies, both with deltas near 1, offer almost dollar-for-dollar exposure to changes in Novo Nordisk's stock price. They mimic the payoff of owning the actual stock without the need for the full capital outlay. However, they come with different risk profiles. The synthetic share strategy involves undefined risk due to the sold put, while the ZEBRA strategy caps the risk to the initial premium paid.
Investors may consider synthetic shares to increase their cash position without sacrificing their exposure to Novo Nordisk's stock. Meanwhile, the ZEBRA strategy might be attractive to investors who want to mimic stock ownership while capping their downside risk.
Ultimately, the choice between these strategies depends on individual investment objectives and risk tolerance. As with any investment decision, it is crucial to conduct thorough research and consider all the factors before initiating any of these strategies.
Options are complex, high-risk products and require knowledge, investment experience and, in many applications, high risk acceptance. We recommend that before you invest in options, you inform yourself well about the operation and risks. In Saxo Bank's Terms of Use you will find more information on this in the Important Information Options, Futures, Margin and Deficit Procedure. You can also consult the Essential Information Document of the option you want to invest in on Saxo Bank's website.
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