Sometimes, when a stock surges on an analyst upgrade, it's high time to make a bearish bet. That's exactly what one big options trader did Wednesday on Walgreen.
Shares of the drugstore company surged 4.2 percent Wednesday to make a new 52-week high, after UBS upgraded the stock to "buy" from "neutral." UBS raised its price target to $48, but one option trader doesn't quite see that in the cards.
In the biggest trade of the day, someone sold 10,000 April 42/43 call spreads for a $0.58 credit. This is a bearish trade that can make a maximum of $0.58 if WAG is below $42 at April expiration—and incurs its maximum loss of $0.42 if WAG is above $43. This trade is basically a simple bet that the stock will be lower than it is now when April expiration comes along.
This thinking contrasts that of the analysts at UBS, who said that despite the stock's strong performance year to date and throughout 2012, it is a buy.
So why buy now? UBS said that the Alliance Boots transaction has settled and will begin positively impacting Walgreen's revenue and earnings. UBS also expects the increased presence of generic drugs in Walgreen's stores to boost gross margins in 2013. Additionally, the upgrade cited Walgreen's carefully constructed loyalty program, the healthcare overhaul, and coverage expansions as further reasons for the stock to appreciate.
The bearish case for the stock is that it is fully valued here, at a 19.2 price-to-earnings ratio, and a price-to-book value of 2.2, which is about in line with the broader market, but above the industry average. After the stock gained 17 percent in three months, this option trader is betting that the stock is due for at least a period of consolidation, if not a moderate correction.
The Dow has been up nine days in a row, and eventually this will have to end. When the market dips, Walgreen is likely to get dragged down with it. In the event that Walgreen continues its rally, this trade caps its losses quickly, because the spread is only a dollar wide. It can be very difficult to pick a market top, so it is very important to use options with defined risk profiles. That will best set you up to risk less and make more.
As you can probably guess, I have no position in Walgreen.
—Brian Stutland is Managing Member of Stutland Equities and a contributor to CNBC's "Options Action."