There has been a fair bit of discussion surrounding the chances of an early stop for REDUCE-IT at the 60% interim analysis. I continue to believe that the chances of a stop at this point are fairly low, and while there are a number of investors who mention that they believe that the chances of a stop are above 50%, there does not appear to be much willingness to put money into the belief of a 50+% chance of a stop.
For example, call options that are well out of the money would likely offer a much better payback than Amarin's (NASDAQ:AMRN) stock in the event of a REDUCE-IT stop at 60%. Anyone who believes that the chances of a stop are greater than 50% would theoretically get over double the expected return compared to the stock by buying some OTM call options even at the ask price. However, the relatively low bids and trading prices indicate that there is not much interest in betting on more than a 10% chance of an early stop.
Expected Value And Returns For The Stock
Here is a table looking at Amarin's expected value based on various chances of a REDUCE-IT stop at the 60% interim analysis and the estimated price for Amarin based on a stop. I've put the estimated price of Amarin with a continuation at a constant $2.40 so that there aren't too many variables.
With a target price of $10 with a stop and a 50% chance of a stop, Amarin's expected value would be $6.20. This calculation is based on taking 50% of $10 (for Amarin's value with a stop) plus 50% of $2.40 (for Amarin's value with a continuation). A target price of $15 and a 30% chance of a continuation would result in an expected value of $6.18. This is based on taking 30% of $15 (for Amarin's value with a stop) plus 70% of $2.40 (for Amarin's value with a continuation).
Stop Chance/Price | $7 | $10 | $15 |
10% | $2.86 | $3.16 | $3.66 |
30% | $3.78 | $4.68 | $6.18 |
50% | $4.70 | $6.20 | $8.70 |
70% | $5.62 | $7.72 | $11.22 |
90% | $6.54 | $9.24 | $13.74 |
The details of what this looks like versus Amarin's current share price of $3.00 is shown in the table below. Amarin's expected value with a 10% chance of a stop and a $10 target price with a stop is 5% above Amarin's current share price. Amarin's expected value with a 70% chance of a stop and a $15 target price is 273% above its current price.
Stop Chance/Price | $7 | $10 | $15 |
10% | -5% | 5% | 22% |
30% | 26% | 55% | 105% |
50% | 56% | 106% | 189% |
70% | 87% | 156% | 273% |
90% | 117% | 207% | 356% |
Thus Amarin stock would generate a fairly decent expected return if you thought that there was a 30+% chance of a REDUCE-IT stop with any of the target prices listed above, of a 10% chance of stop combined with a $15 target price with a stop. However, while the expected value with a 30% chance of a stop looks pretty good, there would still be a 70% chance of the value of Amarin's stock going down after the 60% interim analysis, so one's degree of risk-averseness would also factor into the decision making. Personally I am using a $10 target price and a 10% or less chance of a stop and acting accordingly.
Expected Value And Returns For Options
Here's a similar look at the expected value of December 17, 2016 call options with a $5 strike price. The value of the option if REDUCE-IT continues is expected to be zero, so the expected value is entirely tied to the chance of a stop combined with the excess amount of the target price over the strike price. For example a 30% chance of a stop combined with a $10 target price would result in an expected value of $1.50 for the option based on 30% of $10 less $5 (the option strike price).
Stop Chance/Price | $7 | $10 | $15 |
10% | $0.20 | $0.50 | $1.00 |
30% | $0.60 | $1.50 | $3.00 |
50% | $1.00 | $2.50 | $5.00 |
70% | $1.40 | $3.50 | $7.00 |
90% | $1.80 | $4.50 | $9.00 |
The December $5 call options last traded for $0.28, but I have used a higher number of $0.47 to represent the current ask price where one can accumulate a lot of options (there appears to be over 8,000 available at that price, which would represent over 800,000 shares).
With the $0.47 price, an expected value of $1.50 (the 30% stop chance and $10 target price example listed above) would result in an expected return of 219%.
Stop Chance/Price | $7 | $10 | $15 |
10% | -57% | 6% | 113% |
30% | 28% | 219% | 538% |
50% | 113% | 432% | 964% |
70% | 198% | 645% | 1389% |
90% | 283% | 857% | 1815% |
What Trades Reveal About Odds
During discussions about Amarin, it appears that there are a fair number of investors that have mentioned that they believe that there is a greater than 50% chance of a stop of REDUCE-IT at the 60% interim look. However, the relatively low price of Amarin's options indicate that few investors appear willing to actually put money into their belief that a chance of a stop is 50+%.
If one believed strongly that the chance of a stop was 50+%, the best theoretical move would be to load up on out-of-the-money call options instead of Amarin stock. For example, a 70% chance of a stop combined with a $10 target price would lead to a 645% expected return using the December $5 call options (at a $0.47 price) compared to a 156% expected return with the stock. It actually would even make sense with such an example to sell some of one's Amarin holdings to put it into OTM call options if one truly believed that the chance of a stop was that high. This is because the expected return would be so much greater.
Of course, there is an aversion to risking too much when there is a 30% chance of a complete loss. However, if one put 20% of one's portfolio into propositions that had a 70% chance of returning 10.6x the initial investment (this example), and a 30% chance of a complete loss, after five such investments the chance of a complete portfolio loss is 0.24%, while the chance of at least doubling your portfolio value is 99.76%.
Given that call options that are well out of the money such as the December $5 call options are not being snapped up (or for that matter attracting more than modest bids), my conclusion is that while some investors may be hopeful that there is a 50+% chance of a REDUCE-IT stop, there is little interest in actually risking more money for such a belief.
Since I believe that the actual chance of a stop at the first interim analysis is 10% or less, I don't see the OTM call options as being attractive. If I actually believed that there was a 50+% chance of an early stop, then my actions would be different and I would be purchasing options, although I'd have to double check the soundness of my beliefs in such a case since there is often a tendency to overestimate odds.
Conclusion
I like looking at options to figure out what odds investors are actually willing to put money to support in a binary outcome situation. If one believes there is a 50% chance that REDUCE-IT will be stopped early at the first interim analysis and that the stop will lead to Amarin reaching $10 by mid-December, then OTM call options would appear offer much better results than the stock. The options would be essentially like putting down $1000 for a 50% chance of $0 and a 50% chance of $10,600, while Amarin's stock would be like putting down $1000 for a 50% chance of $800 and a 50% chance of $3,300. Higher estimated stop chances or target prices would tilt the equation more in favor of the options.
However, actual trades and bids indicate that investors are so far only willing to put money down based on a 10% or less chance of a first interim analysis stop (or a moderately higher chance of a stop combined with a lower target price than $10). While many investors are hopeful about an early stop in September/October, the investment activity indicates that investors are expecting that REDUCE-IT will at least go to the second interim analysis.
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