Clinical Data (CLDA) is expected to receive a response from the FDA by Saturday, January 22nd on whether or not their depression drug vilazodone is approved. As in similar PDUFA situations, the news will have massive repercussions for the company’s share price.
I am employing a very wide call butterfly spread (a bullish strategy) to trade this event (it should be noted, however, that I may also add a bearish trade later on). I decided to use a butterfly structure because I wished to put on a larger trade without the desire to risk too much money (required for outright call purchase or call spread purchase) – buying the shares outright, for me, is not a risk I wish to take in this situation.
Here is the trade:
- Buy 50 MAR 25 strike Calls @ 1.012 = $5,060 Debit (=1.012 x 50 x 100)
- Sell 100 MAR 30 strike Calls @ 0.453 = ($4,530) Credit (=0.453 x 100 x 100)
- Buy 50 MAR 35 strike Calls @ 0.243 = $1,215 Debit (=0.243 x 50 x 100)
- Position P&L = $1,745 Debit (0.349 per spread)
Here is the P&L diagram (at expiration) for the trade:
(Click to enlarge)
My risk in this trade is the initial $1,745 debit (or 0.349 per spread) – the mid-value cost per spread was around 0.15~0.20 which I tried to trade into over two weeks. I was unable to do this so I decided to risk between $1,500 and $2,000 on a trade. I was finally able to trade into the position at my mentioned debit ($1,745). The maximum I can make in this trade is a little over $23,000 (if CLDA trades at $30 by March expiration).(1) The profit zone for this trade is very wide, approximately $10 and is between $25 and $35 – this means I make money as long as CLDA trades between $25 and $35 by March expiration(2) – I of course always retain the option to close out the trade at a smaller profit should CLDA trade between these values later on.
CLDA currently trades around $15 a share – hence the stock will need to double by expiration for me to profit! Normally I do not put on trades that require such aggressive price increases. In this situation, however, I decided to go ahead and do the trade for several reasons:
(1) Low share base: CLDA only has about 30 million shares(3) with a very low float.
(2) High short interest: short interest is around 17% – an approval within the context of a very low float can create an explosive upside potential.
(3) Analyst price targets: most analyst estimates for CLDA are around $25 ~ $27 for those who believe in the FDA approval scenario – although I usually haircut said estimates (or doubt them due to investment banking conflicts) several independent analysts had similar price targets which gives me a little more confidence with their accuracy.
(4) Take-over sentiment: be it speculation, rumor or otherwise, this company seems to attract take-over chatter (whether right or wrong) – this can potentially fuel greater share price increases after an approval scenario.
In a failed approval scenario, the structure will collapse and I will incur a full loss – the shares will experience a significant sell-off.
(1) My goal to trade into the butterfly at 0.15 would have allowed me to double the position size and increase the maximum payout to $46,000 with nearly the same amount of risk.
(2) It should be noted that break-even is between $25.35 and $34.65.
(3) It should be noted that conversion of the company’s convertible debt and exercise of outstanding warrants will dilute shares outstanding by around 10.0 million per September 30, 2010 10-Q notes.
Disclosure: Author long CLDA through option strategy described in article