Options Update: Gilead Science Call Volume Soars after Needham ‘Buy’ Rating

Gilead Science
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has quickly become a favorite among Wall Street analysts ever since the company released its third-quarter earnings figures on October 17.

Immediately following the report, BMO Capital markets upgraded the shares to “outperform,” while Banc of America Securities lifted its rating to “buy” on October 25. More recently, on November 6, Wachovia resumed coverage on the shares with an “outperform” rating, and this morning, Needham initiated coverage on GILD with a “buy” rating and a price target of $51 per share.

Putting the icing on the cake, Barron’s published a bullish article on the company this morning, highlighting the security’s appeal as a “good defensive play.” This flood of bullish commentary has proven too much for options traders to resist, prompting a flood of call volume for the equity this morning. In fact, more than 22,000 GILD calls have changed hands so far today, outnumbering the stock’s average daily call volume by nearly 7 to 1 and placing the shares on our Intraday Volume Explosion List. However, it was the fact that nearly all of this activity was concentrated at GILD’s November 47.50 strike that caught my eye today.

Gilead Science option volume details

The Anatomy of a Gilead Science Call Position

Wading into the fray, I was a bit startled to see that nearly all of the more than 20,000 contracts that changed hands at GILD’s November 47.50 call appeared to have been sold. Open interest at this front-month option totals a mere 9,680 contracts, lending credence to the idea that the stock was targeted by sell-to-open call positions. A call-sell position is similar to a put-sell, except that the trader needs the shares to remain below the sold call through expiration in order to keep the premium received. As you might have guessed, I will be running with a call-selling theme this afternoon.

Specifically, a block of 10,000 November 47.50 GILD calls traded at the bid price of $0.40 at 10:32 a.m. Eastern time, netting the trader a total credit of $400,000 — ($0.40 * 100)*10,000 = $400,000. As noted above, a call-sell trader keeps the premium received on the trade as long as the underlying shares remain below the sold strike through expiration, which, in this case, is November 21, 2009.

By entering this trade, the investor is indicating that he expects GILD to remain below $47.50 per share through the end of next week. The shares have pulled back below resistance at the 45 level this week, but let’s see if the stock’s technical or sentiment backdrops provide any additional drivers for this trade.

Getting Technical

Technically speaking, GILD has staged a nice comeback from its early-October lows near $35.50 per share. In fact, the equity has surged more than 24% during this time frame, supported loosely by its 10-day and 20-day moving averages. However, the shares have broken down since the beginning of November, and have dipped back below these short-term trendlines. More importantly, GILD is now trading back below staunch resistance at its 10-week moving average. The shares have not bested this trendline on a weekly basis since late-August. Complicating matters further is staunch technical resistance at the 45 and 47.50 levels. Both regions have halted GILD rallies in the past, and could favorably impact a sold November 47.50 GILD call.

Weekly chart of Gilead Science since August 2008 with 10-week moving average

The Sentiment Drivers

The stock’s sentiment indicators are also aligned positively for today’s call-selling example. Specifically, short interest surged more than 47% during the most recent reporting period, but GILD’s short-to-float ratio rests at a slight 3.9%. This ratio indicates that short sellers are far from overly exposed to the shares, hinting that there is room for more bearish traders to jump onto the short-selling bandwagon. Naturally, such a development would provide additional downward pressure on the shares, potentially sending GILD sharply lower.

Meanwhile, Zacks.com reports that 17 of the 20 analysts following the security rate it a “buy” or better. If the past few weeks of bullish commentary from Wall Street is any indication, downgrades from this optimistic group is relatively unlikely. That said, there is very little room left for additional upgrades, potentially putting a crimp in the stock’s momentum over the short-term.

Sentiment indicators for Gilead Science

The Verdict?

With little more than a week until November options expire, selling a GILD call at the 47.50 strike seems like a solid plan. Your returns are limited to the premium received upon imitation of the trade, but, in this market, any profit is a welcome sight. On a final note, a more adventurous trader might consider a December or January 2009 47.50 put. Given the sentiment indicators above (i.e. excessive degree of optimism among analysts and the growing pessimism among short sellers), there is the very real possibility that GILD could extend its recent weak price action and continue lower over the intermediate-term.

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Copyright Schaeffer’s Investment Research. www.schaeffersresearch.com.