Investing in Biotech stocks can be an exciting, yet risky investment. Investing in Biotech options can takes that same risk/ reward to another level. Assessing how these stocks react to certain news concerning FDA approvals and clinical trials is an art in itself and requires specialized knowledge. However, once you learn the process, there are times where the profits you can make off one trade will be more than most people make in a year.
Biotech stocks can experience extreme volatility as drugs pass through different phases and Food and Drug Administration (FDA) processes. In most cases, the rise and fall of a company’s stock price can be tied to one important drug. It’s the one drug that can take a small biotech firm and make it into a major one. All it takes is a billion dollar drug.
When you hear about a company’s drug passing through clinical trials you want to watch for how effective the drug is and if there is a good chance it can gain approval. Then you have to figure out what the potential sales for the drug are.
The homework is essential because options traders live for these types of trades because if you own the right call or put options they can make you as much as 500%-800% on the news. That was not a typo.
One stock that I have been watching for a couple of years now may be on the verge of doing just that.
Dendreon (DNDN, $4.29, up $0.07) has been making headlines lately after reporting better-than-expected earnings but Wall Street is eagerly awaiting the outcome on one of its cancer drugs, Provenge. This is Dendreon’s crown jewel and it targets Prostate cancer which is the second most common cancer affecting men in the U.S. and one of the leading causes of cancer-related death.
A couple of years ago, Dendreon was in the exact same spot it is in now and back then I talked about the risk and rewards of playing these types of events. I profiled both call and put options that made 500% moves in a matter of days. On 3/28/07, the stock was halted on a Wednesday at $5.22 and did not open until Friday. When the stock did open, it was at $17.92 but finished the day at $12.
The April 5 calls were trading at $1.25 on that Wednesday. Guess where they OPENED on Friday morning? $12.60. The calls eventually closed around $8 for a 500% gain in less than two days.
Dendreon would make it to a high of $25 by 4/10/07 but was back down to $5 a month later after Provenge did not get FDA approval. Dendreon’s shares were rising and falling that fast as the debate about whether or not Provenge would get FDA approval.
The reason for the rapid rise and sudden fall was due to the FDA panel saying Provenge is safe, and that there was “substantial evidence” that it works in treating advanced prostate cancer. In other words, traders were taking the panel’s word as a sign the drug was going to get approved but the FDA does not have to follow the panel’s recommendation. At the time, the panel had said that the drug needed further study before it can be approved, but voted “Yes” by a 13-to-4 margin. That is what pushed the stock from $5 to $25.
When the FDA denied approval, Dendreon shares tanked back below $7 on the news.
Fast-forward to today.
Dendreon was expected to submit to the U.S. Food and Drug Administration last year but the application for Provenge has been delayed until now. The good news is that the final results from the study shows that the drug reduces the risk of death by 20%. The company expects the final results of the study to be released in late April.
It’s difficult to value a company’s pipeline, but assuming Provenge could become a breakthrough treatment for patients with advanced prostate cancer, I would guess sales could have the potential to reach $1 billion. Based on this forecast, it is why this stock hit $25 to $30 a share.
Since we aren’t expecting the an announcement until late April the first option chain we can look at is the May call options. The one thing I want to show you is how much the options are trading at a premium.
Here is a list of the four closest strike prices for the Dendreon May call options:
May 5 call (UKOEA, $2.22, up $0.22) Bid: $2, Ask: $2.22
May 7.5 call (OKOEU, $1.66, up $0.09) Bid: $1.55, Ask: $1.70
May 10 call (OKOEB, $1.30, up $0.10) Bid: $1.25, Ask: $1.30
May 12.50 call (OKOEV, $1.00, up $0.01) Bid: $0.95, Ask: $1.07
May 20 call (OKOED, $0.50, up $0.05) Bid: $0.40, Ask: $0.50
Now look at the options for DryShips (DRYS, $4.14, down $0.01). These are June options because the May options have yet to list and there are no June options for Dendreon.
June 5 call (OOCFA, $0.95, down $0.05) Bid:$0.95, Ask: $1.05
June 10 call (OOCFB, $0.30, up $0.01) Bid:$0.20, Ask $0.30
June 20 call (OOCFD, $0.05, unchanged) Bid: N/A, Ask $0.05
The June options are even further out then the May options and both stocks are under $5. Yet, notice the huge price difference in the both the 10 and 20 call options prices.
So here is the bottom line. If you believe history has a chance to repeat itself and Dendreon will trade from $5 to $25, how do you play it?
The May 5 calls are going for $2.25. Lets say the stock hits $15 before $20. For $2,250 you could buy 10 call options. If Dendreon hits $15, the investment is worth at least $10,000 because the options would be in-the-money by $10. If the stock hits $20, you’re at $15,000.
The May 10 calls are selling for $1.30. For $2,600 you could buy 20 call options. If the shares are at $15 that gives the options a $5 in-the-money profit and you would net you $10,000. If the stock is at $20, you’re at $20,000.
There’s more bang for the buck with the 10′s but if Dendreon doesn’t mirror the move that the stock made two years ago, there is also the chance of a bigger loss.
You could buy half of each if you really wanted to and you can play around with the figures on the other strike prices to see what you get. In fact, if any of you need help figuring out where an option will trade when a stock hits a certain price, email me.
As you can see, there are a lot of ways to play this so figure out what suits you.
Either way, expect more volatility in the coming weeks as Dendreon moves closer to its expected FDA ruling. The average daily volume is around 2 million shares and on March 13, the stock traded 8 million shares after its earnings release.
Two years ago volume approached 93 million shares that Friday which was more than the 76 million shares the company had outstanding at the time.
The 52-week high for Dendreon is $10 and I would expect that we go higher than that if the drug is approved. This is a high risk trade with the chance of either hitting it big or losing much of the capital you put up if the drug is NOT approved.
Of course, I’ve been mentioning buying 10 contracts of the May 10 call options but here is one instance where even a $130 could turn into $500. It’s like getting 5-to-1, or 10-1 on your money on something that looks pretty positive. There will be no stops for these positions.
Rick Rouse
Rick@OptionsMentoring.com
Get RSS Feed
Bank of America Swells Up
Wednesday, March 18th, 2009
Bank of America (BAC, $7.67, up $1.40) had another fantastic outing as the stock added another 22% today. Talk about having a tiger by the tail. The stock started higher right out of the gate and continued its upswing throughout the session after the company’s CEO said BofA could repay the $45 billion government TARP loan by late 2009 or early 2010, depending on the economy.
BofA closed above $7 for the first time since late January and got an added lift after the Federal Reserve announced plans to buy up to $300 billion of long-term Treasury notes. By doing so, the Fed is showing its commitment to pump money into the financial system and encourage lending.
After the Fed news, the stock continued its rally and closed at its high. In after-hours trading as I type, the stock is up another 28 cents to $7.95.
Now for the best part.
The May 6 calls (BYOEF, $2.75, up $1.10) were entered at 75 cents on 3/11/09 and as of today’s close that represents a return of 267%! I have been talking about protecting your profits with this one all week and it would be prudent to set stops at $2.50 RIGHT NOW if you haven’t done so already.
The July 10 calls (JLWGB, $0.95, up $0.42) surged 80% today and we had an exit target of 60 cents. With today’s huge gain, you should now raise the exit target/ stop to 80-85 cents. The total return for this trade is 217% and a stop of 90 cents gets you a 200% return.
If the stock holds it gains in after-hours trading then these call options could continue to do well. Just remember, if you sell half of the position at 200% it means you made a 100% on your original investment and you could let the rest ride until May and July which is when these options expire. The May 6 call options are now in-the-money by $1.67 (stock price minus the 6 strike price) so they should move nearly dollar for dollar if BofA continues up.
These are tough choices because greed can take over here and all it takes is one bad day or a 20% drop in the stock to take a big dent out of these profits. Keep that in mind and at least close half of your position by the weekend.
I’m working on a big article for Dendreon (DNDN, $4.29, up $0.07) for Thursday’s blog and it could be one of those “special” option plays that only comes around a few times a year. I have talked about this stock in the past and you’ll be excited to read the update. Trust me.
Rick Rouse
Rick@OptionsMentoring.com
Tags: Bank of America, Dendreon
Posted in Company Commentary, Hot Stocks, Option Trades | No Comments »