Gilead Sciences (GILD 0.77%) has been one of the best-performing biotech stocks over the past five years, In fact, this large-cap biotech has been absolutely crushing the broader industry, shown by this comparison of Gilead vs. the iShares Nasdaq Biotech ETF (IBB 0.66%):
The catalyst behind Gilead's stellar performance is no secret, with its hepatitis C franchise drugs Harvoni and Sovaldi generating monstrous revenue growth for the company ever since their respective commercial launches.
However, the market seemingly lost its taste for Gilead to some degree this year, presumably because the biotech's top line is expected to shrink by 1.3% in 2016, according to data provided by S&P Capital IQ. The basic issue is that the hep C market appears to be near the saturation point, and newer drugs could start to erode some of Gilead's overwhelming dominance moving forward.
As a direct result, Gilead's stock has slightly underperformed the iShares Nasdaq Biotech ETF in 2015:
Investors were thus hoping the biotech would gobble up a revenue-generating company to kick-start its growth engine. Instead of listening to the calls from Wall Street, however, Gilead did what Gilead tends to do on this front -- striking a relatively small $2 billion-ish deal with Galapagos NV (GLPG 1.50%) for its experimental JAK1-selective inhibitor, filgotinib, for inflammatory disease indications.
While filgotinib's midstage data were impressive, the drug, if approved down the line, will end up competing in an increasingly crowded space and probably face stiff competition from the likes of AbbVie's rival experimental therapy, ABT-494. Moreover, it won't make any impact on Gilead's top line in 2016.
So there's a real chance that Gilead's stock will underperform the broader biotech industry yet again next year. But that doesn't mean investors should dump their shares in frustration.
After all, Gilead has proven to be a great stock to buy and hold for the long term because of management's keen ability to identify and subsequently develop groundbreaking new medicines. Furthermore, this biotech offers a dividend, positive cash flows in excess of $18 billion moving forward, and a superb clinical pipeline that is rapidly building out a formidable presence in oncology.
In short, there are a lot of reasons to remain patient with Gilead while its next generation of products work their way through clinical trials.
Here's one way investors can profit from a stock's quiet period
One easy way to amp up your annual return on Gilead is by selling call options against your long position (covered calls). To understand this strategy, though, we first need to go over some background info on call options in general.
A call option is a contract that gives one the right to buy 100 shares of a stock at a particular price, referred to as the "strike price", by a given date (the expiration date). So, when you are selling a call, you are offering to sell 100 shares of a certain stock at a given strike price and expiration date.
The main point of selling a call is to earn what is known as a "premium", which consists of an intrinsic value and a time value. The intrinsic value of a call option is nothing more than the difference between the stock's market price and the option's strike price; when this value is negative, the option has zero intrinsic value. An option's time value is simply a reflection of the time until the expiration date; options with longer periods until expiration have higher time values and vice-versa.
How to get the most out of your Gilead shares now
With this basic primer in mind, let's now work through an example.
To write a covered call, you'll first need the 100 shares of Gilead in your brokerage account ("covered" means you own the stock prior to writing the option). As the stock is trading at around $100, this means you'll need to invest $10,000 to grab enough shares to employ this strategy.
The next step is to consider the most beneficial call option to write. If your intent is really to hold the shares for the long haul, your best bet is going to be an option with a high time value.
So let's say you sold one covered call with an expiration date of January 2017 at a strike price of $110 for a premium of $10 (nice round numbers for didactic purposes). By doing so, you'll receive $1000 ($10*100 shares), not including brokerage fees.
The main risk associated with this strategy is that someone may call your shares away if Gilead's stock starts to move higher. But they'll still have to pay you $110 per share to do so.
What this means is that you would turn a 20% profit (10% from the difference between the $110 strike price and the $100 purchase price, and 10% for the premium earned from selling the call option) if this scenario came to pass. That's a respectable gain by any measure, and it doesn't include any dividends paid in the interim.
By selling a covered call, you are also giving yourself a cushion against a downturn in Gilead's share price. What do I mean? Let's work through another example.
Say Gilead has a really bad year. AbbVie's rival hep C therapy takes far more market share than many people were expecting, and Gilead's shares drop 20% in 2016. Come January 2017, your covered call expires worthless, meaning you get to book the $1,000 profit.
So instead of looking at a 20% paper loss -- or an actual loss if you sell the shares -- it's really only 10%. That's a big difference, and one of the more underappreciated advantages of selling covered calls.
Key takeaways
Foolish investors know the tremendous power of taking the long view when it comes to investing in stocks. However, there are always going to be lulls in the action of your favorite stocks, but that doesn't mean there aren't ways to put them to work. Writing covered calls is one particular strategy that can provide you with income and reduce your risk during quiet periods, making it a good technique to have in your investing arsenal.
