Recommendation No. 2: Bristol-Myers Squibb (NYSE: BMY)

“Sell to Open” Bristol-Myers Squibb September $35 Call

Option Symbol: BMY120922C35

Limit Order Price: $0.75 or more

Directional View for Underlying Stock: Neutral

Personal Finance Portfolio: Income

• Income generated: $75 per options contract (representing 100 shares of stock)
• 92-day rate of return at current stock price of $34.74: 2.2 percent (8.6 percent annualized)
• Tell your broker:

“I want to sell a covered call against 100 shares of my Bristol-Myers Squibb (BMY) stock. Specifically, I want to ‘sell to open’ one September $35 call for a credit of $0.75 per share or more.”

• Remember: You should only sell one call option per 100 shares of stock purchased. The trade can only be done in 100-share increments (100, 200, 300, 400, 500, etc.).

Alternative Trade for Those Who Don’t Already Own Bristol-Myers Squibb:

Buy/Write on Bristol-Myers Squibb (NYSE: BMY): Buy the Stock and Simultaneously “Sell to Open” the September $35 Call

Option Symbol: BMY120922C35

Limit Order Price: $33.99 or less (stock is at $34.74 and September $35 call is at $0.75)

Directional View for Underlying Stock: Neutral

Personal Finance Portfolio: Income

• Net cost of buy/write: $3,399 per 100 shares
• 92-day return if stock does not move: 2.2 percent (8.6 percent annualized)
• Brokers vary as to whether they call this trade a “buy/write” or a “covered stock” trade.
• Do the trade simultaneously at a single limit price, if possible. For example, if you want to buy 100 shares of stock, tell your broker:

“I want to do a buy/write trade. Specifically, I want to buy 100 shares of Bristol-Myers Squibb (BMY) and ‘sell to open’ one September $35 call for a net debit of $33.99 per share or less.”

• Some brokers require that you buy the stock and sell the call in separate trades. If your broker is one of these, always buy the stock first and sell the call against it second:

Trade No. 1:

“I want to buy 100 shares of Bristol-Myers Squibb (BMY) for $34.74 per share or less.”

Trade No. 2:

“I want to sell a covered call against 100 shares of my Bristol-Myers Squibb (BMY) stock. Specifically, I want to ‘sell to open’ one September $35 call for a credit of $0.75 per share or more.”

Please note: When doing a buy/write trade in two steps rather than in one simultaneous trade, the important thing is to limit the net cost of the buy/write to $33.99 per share. The specific limit prices of the individual “buy stock” and “sell covered call” trades are just starting points and should be adjusted as needed, keeping the net cost of the overall buy/write in mind.

• Ex-Dividend Date: The stock’s next quarterly ex-dividend date is around June 29th. Since this ex-dividend date is more than two months prior to September options expiration, the time value associated with the September $35 call–combined with the amount by which the $35 call is out of the money–is very likely to be larger than the $0.34 quarterly dividend, so there is little chance of the call holder exercising early to capture the dividend.
• Why the September $35 Strike?: Personal Finance associate editor Roger Conrad has set a “buy below” target of $34 on the stock. With the stock currently trading above this target at $34.74, it is prudent to sell a covered call at the $35 strike. Bristol-Myers is performing well, but last month it lost patent protection on its Plavix blood-thinner drug and that loss may temporarily depress earnings over the coming months. Furthermore, its $2.5 billion acquisition of Hepatitis-C drug developer Inhibitex was expensive and will dilute earnings through 2016. Nevertheless, these are short-term concerns and Bristol-Myers remains an excellent long-term investment with a bullish-looking chart.

Price Adjustments Regarding This Trade

Stock prices are currently fluctuating and option prices fluctuate with them. Consequently, the limit prices recommended in this trade alert may no longer be immediately fillable by the time the alert has been released. The alert is valid for seven trading days, so be patient and place your limit orders as “good ‘til canceled” (GTC) for seven days.

Investment Rationale for Underlying Stock:

Bristol-Myers Squibb (NYSE: BMY) in April reported an 11.7 percent rise in earnings for first-quarter 2012, on the strength of higher drug sales and a gain from a legal settlement.

Bristol-Myers reported that first-quarter earnings reached $1.1 billion, up from $986 million in the first quarter of 2011. Revenue increased about 5 percent, to $5.2 billion from $5 billion a year earlier. The results roughly met analysts’ consensus. Management confirmed its previous earnings-per-share forecast for 2012 of $1.90 to $2.00.

The company’s first-quarter results included a $172 million gain from a legal settlement against Apotex Corp, Canada’s biggest drugmaker, ending a decade-long patent infringement battle that involved Apotex selling generic Plavix while still under patent to Bristol-Myers. Plavix, the world’s second-best selling drug, is a blood-thinner administered for protection against fatal or non-fatal heart attack or stroke. Bristol-Myers’ revenue from Plavix in the first quarter was $1.7 billion, down 4 percent quarter over quarter.

Plavix’s sales are expected to plummet now that the drug’s patent has expired. That said, Bristol-Myers has a “deep bench” of product development that should offset the decline.

In February, Bristol-Myers bought biopharmaceutical company Inhibitex for $2.5 billion. Although Bristol-Myers paid a 163 percent premium for Inhibitex’s shares, the deal dramatically strengthened the company’s long-term pipeline of products, as it faces a “patent cliff.”

The Inhibitex acquisition is the largest of Bristol-Myers’18 deals since 2007, when it inaugurated its “string of pearls” strategy to offset the loss of patent exclusivity on several key drugs. Bristol-Myers is not alone in facing a patent cliff, as the broader pharmaceutical industry is currently suffering a wave of patent expirations that will cost the industry tens of billions of dollars.

Inhibitex’s crown jewel is a hepatitis C drug in mid-stage human testing called INX-189 that diminishes virus levels in the bloodstream, preventing resistance to medical treatment.

The World Health Organization estimates that roughly 170 million people are infected with the hepatitis C virus (HCV), with 3 million to 4 million cases added annually. At present, the HCV market stands at $3 billion, but analysts expect it to grow to $20 billion by 2020. With its financial power funding Inhibitex’s proprietary processes, Bristol-Myers may capture the lion’s share of this market and extend its lead in the race to dominate the market for future drug treatments.

Also in the first quarter, Bristol-Myers forged a partnership with the Duke Translational Medicine Institute, to jointly test a new and promising treatment for idiopathic pulmonary fibrosis, an increasingly common ailment in which lung tissue becomes scarred and breathing is impeded.

Bristol-Myers annually invests $3.5 billion in research and development, a substantial portion of which is devoted to late-stage pipeline products.

Roughly 80 percent of the company’s potential medicines enter clinical trials, compared to an industry standard of 50 percent.

Bristol-Myers plans to seek approval of five new drugs in 2012. Among them is Brivanib, now in Phase III development for the treatment of hepatocellular carcinoma (HCC). About 700,000 patients are diagnosed with HCC annually worldwide.

Another is Dapagliflozin, a treatment that controls glucose and lowers blood pressure and weight in patients with diabetes, a disease that’s rapidly growing worldwide. In early June, the company reported promising results from a Phase III clinical study in which a combination of Dapagliflozin and Sitagliptin, a DPP-4 inhibitor, achieved significant reductions in blood sugar levels for adults with type 2 diabetes. These results were sustained over a period of 48 weeks. Bristol-Myers Squibb is rated as a buy below 34 in the Personal Finance Income Portfolio.