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This year I have spent some time looking at the success of a "sell the news" strategy with biotech stocks. The news event being sold was the announcement of a positive FDA decision for a company's drug. I have been using a simple strategy to look at the validity of this approach. To recap, the strategy is:

  1. To short the stock at the first open after the news release. If the approval announcement is after hours or intra-day, sell at the open the next day. If the approval comes pre-market, sell at the open the same day,
  2. Buy back at the close on subsequent days.

I have reviewed the results of this approach in two articles. The first looked at the period from January 2011 to March 2012. The second covered April and May.

I looked at the results over a range of holding periods from one day (selling at the close on the same day the trade is entered) to five days. Between January 2011 and April 2012 there were 15 trades. The results for these trades were as follows:

Days held1235
Number of trades15151515
Winners1313129
Losers2233
Average return9%12%13%15%

In the interests of continuing to work towards a robust data set I would like to update these results with approvals that have been handed down by the FDA in the last 7 months. I will break down the update into 2 articles for the sake of readability. This article will cover June and July - a very fruitful period for the industry with five approvals.

Xenoport (NASDAQ:XNPT)

On June 7th the FDA approved XNPT's drug Horizant for use in patients with postherpetic neuralgia. Horizant was initially approved in the US in April 2011 for use in patients with restless leg syndrome. The stock started 2012 at ~$4. On the day of the approval announcement it closed just over $6.

The strategy outlined would have taken a shot position at the open on June 8th.

(click to enlarge)

The strategy would have generated the following results:

Holding period (days)12345
Returns3.4%7.8%5.1%6.3%-4.5%

Arena Pharmaceuticals (NASDAQ:ARNA)

On June 27th ARNA announced the coup of having the first obesity drug approval in decades. Belviq was given the nod for use in the chronic management of obesity. The weight-loss stocks enjoyed a lot of attention over the first 6 months of the year. IN January ARNA traded at a low of ~$1.50. Five months later it closed at $11.39 on the day of its approval.

Following the strategy being investigated would have resulted in a short position being taken at the open on June 28th.

(click to enlarge)

Closing the position over the following 5 days would have given the following results:

Holding period (days)12345
Returns8.5%10.8%11.0%10.4%-1.5%

Vivus (NASDAQ:VVUS)

On July 17th VVUS followed ARNA by announcing that its drug Qsymia had been approved for use in chronic weight management in patients. On January 3rd VVUS closed at $9.90 - on the day of its approval it closed at $26.46.

Our strategy would have required selling VVUS at the open on the morning of July 18th. The stock would have been bought back at some stage over the following 5 days.

(click to enlarge)

The strategy would have resulted in the following gains:

Holding period (days)12345
Returns4.4%15.0%20.4%26.2%24.2%

Amarin (NASDAQ:AMRN)

On July 26th, AMRN announced that the FDA had approved its drug, Vascepa, for use in patients with severely high triglyceride levels. In the pivotal MARINE trial, AMRN had demonstrated a statistically significant reduction in triglyceride levels. Prior to the approval AMRN's stock price had gradually improved from a 2012 low of $6.38 to a high of $15.58 just days before the decision.

The strategy would have called for selling AMRN at the open on July 27.

(click to enlarge)

Potential returns from the strategy were as follows:

Holding period (days)12345
Returns11.5%16.8%23.3%24.5%24.4%

Horizon Pharma (NASDAQ:HZNP)

Also on July 26th, HZNP announced that its drug Rayos (a delayed release formulation of prednisone) had been approved for use in several diseases including rheumatoid arthritis, ankylosing spondylitis, and COPD. In the 6 months prior to the PDUFA date HZNP traded largely in a range between $3 and $4.50. It broke out of this range in June at which time it ran quickly to the mid $8s. On the day of the approval it closed at $7.64.

Following the standard strategy would have required selling HZNP at the open on July 27th and buying back at one of the five following closes.

(click to enlarge)

The results yielded by this approach would have been as follows:

Holding period (days)12345
Returns7.2%14.7%16.0%24.6%25.3%

Conclusion

This strategy has continued to perform extremely well through the year. I believe that the results are worth bearing in mind as investors deal with upcoming FDA decisions. Several companies have a PDUFA coming up in the near term. These include Alexza (NASDAQ:ALXA), NPS (NASDAQ:NPSP), Aegerion (NASDAQ:AEGR), Santarus (NASDAQ:SNTS) and NuPathe (PATH). If an investor owns stock in one of these and decides to hold through an approval, this analysis suggests that selling quickly after the decision is announced may offer an opportunity to re-enter at a lower price. Additionally, if it is possible to find shares to short, there may be some short-term potential in selling short immediately after the approval.

Source: Selling FDA Approvals: Latest Results