Chelsea Therapeutics (NASDAQ:CHTP) is waiting for a critical FDA decision on its drug, Northera. The FDA decision is expected by February 14, 2014 and could be the end of the two rounds of applications seeking approval of the drug. The history of clinical trials and FDA actions were presented in our previous article here.
Chelsea has gone through a bumpy road in pursuing FDA approval in the US for Northera™ (droxidopa), a novel, late-stage, orally-active therapeutic agent for the treatment of symptomatic neurogenic orthostatic hypotension (nOH) in patients with primary autonomic failure (Parkinson's disease, multiple systems atrophy, and pure autonomic failure). The drug was acquired from Dainippon Sumitomo Pharma Co. Ltd. in 2006. The company has the global development and commercialization rights to Northera, excluding Japan, Korea, China, and Taiwan. It was granted orphan drug status for the treatment of nOH from FDA in 2007. The only approved drug for nOH is Midodrine by Shire plc. Midodrine has a limited success in treating nOH.
Chelsea has conducted multiple phase III clinical trials of Northera with mixed or limited success. Chelsea submitted its application for approval of Northera in 2011. The Cardiovascular and Renal Drugs Advisory Committee (CRDAC) voted 7:4 in favor to approve the drug in February 2012, but FDA rejected the drug in March 2012, requesting more clinical trial to demonstrate the durability of the drug. Chelsea resubmitted the application with new data in 2013, and the last CRDAC meeting on January 14, 2014 voted 16:1 in favor to approve it. The FDA is due to make its decision again on February 14, 2014.
The FDA action will be one of three possibilities: approval, no decision (delay), or non-approval (complete response letter or CRL). Investors have strong opinions on the FDA decision. In this article, we will only focus on the main reasons for each scenario, and we will propose trading strategies accordingly. The market data used here were of Friday, February 7th. The stock was closed at $4.79.
Approval With Restrictive Labeling
This camp believes FDA approval this time because of the following reasons:
- It is hard for FDA to reject a second positive FDA advisory panel voting of 16:1 in favor of approval;
- Because of the unmet medical need, FDA has shown laxity of approvability even if the drug lacks long-term durability, should the company conduct a larger trial to prove or disapprove the long-term benefit vs. risk;
- The drug has already been approved in Japan.
The most recently published Seeking Alpha article has summarized the bullish wishes well. Bullish investors think the stock price will easily eclipse the 52-week high of $5.78. We propose the following two trading strategies for this possible event.
1 to 1 payoff: Buy Feb 4 call, sell Feb 5 call for a $500 debit per 10 vertical spreads.
The breakeven point is $4.50. The max profit is $500 when stock is priced above $5, and the max loss is $500 when stock is traded below $4.
2 to 1 payoff: Buy March 4 call, sell March 8 call for a $1,250 debit per 10 vertical spreads.
The breakeven point is $5.25. The max profit is $2,750 when the stock is priced above $8, and the max loss $1,250 when the stock is traded below $4. This strategy is more bullish, which is good for those who believe that Northera has a high probability of approval, and that price will soar significantly.
This camp believes FDA may delay its decision for the following reasons:
- FDA did not appear ready to approve the drug in its briefing doc released for the last panel meeting on January 14, 2014. However, the agency is pressed hard to approve it, facing a strong voting decision from the advisors. It may need more time to discuss the issue, which may involve higher-ranking officers. One month is not long enough. This opinion seems sitting on the fence.
- The labeling will be complicated for Northera because it is a short-term treatment for a chronic disease. FDA may need more time to communicate with the company and finalize the labeling. This opinion is apparently bullish on final approval.
For the above reasons, delay will be interpreted as a neutral-to-bullish signal, which would likely push CHTP stock price higher than $5. We propose the following trading strategy for this possible event.
At the money Feb iron condor: Sell 5 put, buy 2 put, sell 5 call, buy 8 call for a $1,650 credit per 10 contracts of each leg.
The max profit is $1,650, with a profit zone of $3.35-$6.65. The max loss is $1,350 when the stock is traded above $8 or below $2.
This camp believes FDA may issue a CRL again for the following reasons:
- Just like the first FDA reviewer, the second FDA reviewer was still negative, and clearly suggested non-approval on her briefing doc;
- The last panel's 16:1 voting result sounds overwhelming, but considering the debates, the reasoning by the voters, and the interpretation of the voting question by the chairman of the panel, the voting result may not move the heart of the agent.
- FDA approval will set a bad precedent of approving a drug with flawed clinical designs and a questionable benefit/risk ratio. Please refer to our previous Seeking Alpha article that summarized the history of Northera clinical trials. In the second panel meeting, FDA lamented the conduct of Study 301 in Eastern Europe. Specifically, two sites that contributed the most positive data have clearly faked the records.
A second CRL would likely be a death penalty for this tiny company without other drugs in pipeline. The stock may be traded at cash value, well below $1. We propose the following trading strategy for this possible event.
A 1:3 back ratio put option strategy: sell 10 contracts of Feb 5 put and buy 30 contracts of Feb 3 put, resulting in a net credit of $500.
The breakeven points are either below $2.25 or above $4.5. This strategy captures large profit if FDA rejects Northera again. If stock drops to $1, the net profit will be $2,500, a 5-fold swelling of initial $500 credit. If FDA approves the drug, we expect stock will stay above $5, and investors will still happily keep the initial $500 credit. The risk is the FDA delaying its decision. The peak loss could be $1,500 if stock closes at $3 when the options expire on February 21. But delay is viewed as neutral-to-bullish condition for the stock, the risk could be quite low.
The FDA decision for Northera's approvability is an uncertain binary event. A dramatic movement in stock price is expected. Naked long or short stock or options are not recommended. While we are still expecting that a second CRL is coming, as we believe that the FDA has not warmed up yet to approving the questionable drug, our trading strategy is prepared for a possible approval as well.
The purpose of this article is to present investors, who are looking at a binary event, a better strategy for surprising news. The alternative is to abstain from the temptation to trade ahead of the event but rather wait until the news is released. Overconfidence could be counterproductive or even destructive should the event turn out to the opposite of your expectation.
This article was co-authored by Nick Zheng and Ted Arhontas.
Additional disclosure: I am short CHTP using a back ratio put option strategy as described in this article.