It’s been a rough couple of days for Merck (MRK, $31.33, down $4.00). The stock followed Monday’s 6% decline with a 11% drop on Tuesday after lackluster earnings and some damaging information for the company’s cholesterol drug Vytorin.

On Monday when Merck was at $36, I mentioned that earnings were delayed and that pending news was due out concerning Vytorin. Merck came out later that day and said that researchers reported the drug was ineffective in stopping progression of a condition called “aortic stenosis”, or a small blockage of the heart’s aortic valve. That’s when the selling intensified.

You just had this feeling that it wasn’t going to be good news. I mentioned investors had bought the August 37.50 calls (MRKHU, $0.10, down $0.50) and the August 40 calls (MRKHH, $0.05, down $0.25) on Friday in anticipation of a good earnings report come Monday morning. Afterall, investors were expecting double-digit growth and there is a shift into Drug stocks right now, so I can see why we had heavy call volume on Friday.

When Monday came and I noticed that earnings were delayed, I started watching the volume in the August 35 puts (MRKTG, $3.80, up $2.65) and I mentioned they were the most active in the August put chain. They were selling for 85 cents at the time. Yeap, the percentage gain on that one comes out to 335% as of yesterday’s closing price.

Although the reaction or the sell-off is overdone, the puts may have ran their course and it would be wise to set stops at $3.40, which sets your stop at a 300% gain. Merck is another company that looks attractive at these levels if you only deal with stocks and it’s too early to even think about going long any call options. For the meantime though, enjoy the short position you have but make sure your exit points are in place.

Rick Rouse