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Summary

  • Vertex Pharmaceuticals soared 50%+ pre-market this morning (June 24, 2014).
  • Binary events result in large moves in either direction.
  • A structured Note recently issued on VRTX provided enhanced yield at the cost of downside risk and limited returns.
  • Investors should be cognizant of upcoming binary events and consider solutions that better balance the risk/reward tradeoff.

This morning, Vertex Pharmaceuticals (NASDAQ:VRTX) announced positive results for phase 3 clinical trials. As a result, the stock soared 50%+ pre-market, surpassing $100 for the first time in the firm's history. Of course, an unsuccessful outcome would have resulted in an extraordinary move in the opposite direction; clinical trial outcomes such as these present extreme binary events to investors.

In late February, 2014, a structured note was issued with roughly $20 Million in notional on VRTX. As I wrote in my blog post on binary events as well as an earlier article in Seeking Alpha, this structured note presented investors with two unattractive outcomes - if the VRTX clinical trial was successful, the stock would appreciate significantly and the structured note would be called early and investor returns would be capped at a modest 5.5% yield (about 11% annualized). If the trial was unsuccessful, the stock would take a substantial hit, perhaps substantial enough to eliminate any principal protection and thus expose investors to a major loss.

Since VRTX is now well above the issuance price of $84.81, the note is due to be called August 21. Investors will receive their principal back at that time, resulting in a grand 5.5% total return over 6 months. In contrast, as of this morning's opening, VRTX was up 15.6% as compared to the price when the structured note was launched; thus, investors who owned VRTX outright will finish considerably ahead of owners of the structured note.

In conclusion, the structured note I analyzed offered a tantalizing annualized yield, but exposed investors to a major potential loss with limited upside. If investors plan to pursue investing in binary events, they might want to consider solutions which better balance the risk-reward tradeoff.

Source: Positive Results For Vertex Pharmaceuticals; Ok Results For Structured Note Holders