Orexigen Options: A Lesson in Trading Biotech

Feb. 1.11 | About: Orexigen Therapeutics, (OREX)

We are hearing that SAIC's Steven Cohen bought a 7.2% position in Orexigen Pharmaceuticals (NASDAQ:OREX). He is going to get crushed this morning. I'm sure it only constitutes a small part of one of his portfolios though, and he will be just fine. That being said, is there a better way to trade Biotech? Of course there is, using options to take both sides of the trade.

Yesterday, I too decided that I would trade Orexigen. I bought 5 of the Feb 12 Calls @ $1.00 a piece. Those were for the considerable upside that would result upon approval. Just think of it, your nightly news, your local TV station, CNBC, anyone and everyone would be cheering the first diet drug the FDA has approved in ages. We would have regular Joes who never trade calling Schwab or Fidelity to get some. Short interest too could have seen Orexigen blow past $20.00/share. But, I also believe in risk management. As a result, I also bought 3 of the Feb 7 puts for $1.00 as well. My theory was that Orexigen would go to $2.00 if the drug was denied by the FDA.

As it turns out, Orexigen's drug was "pretty much" denied by the FDA. The FDA had concerns about the cardiovascular risk of Contrave and will thus not approve Contrave without an extremely exhaustive Cardio study. It would appear as though the market is taking this as "essentially, a total denial." One can see why, as in the case of Arena (NASDAQ:ARNA) the additional delays for further studies are so hurting the company's ability to survive that the company has had to lay off 25% of its workforce. Massive time delays for unprofitable biotechs needing an approval may be the death nail in many cases.

Currently, Orexigen is trading around $2.50 a share. My guess is that with a little time premium built in, the Feb 7s will trade at $5.00 at the open. I put my order in for that amount. The calls will of course be worthless. So what will become of my trade? Calls cost me $500, puts cost me $300. Total outlay: $800. If I get my $5.00 then we are talking $1500, for $700 or 87.5% profit on the position. Not bad for one night's work.

What was the risk? A decision that was really "lukewarm." Perhaps a 60 day delay in a decision, which could have had the effect of the stock not moving and sucking the premium from the options. I need a strong decision either way, (approval/denial), for the position to be profitable. I got that. But the lesson here is that taking a side 100% on one side or the other will just result in you losing all your money. Do a bipolar options trade for pharma events and you will not lose your shirt and may even make some money as I have.

Disclosure: I am short OREX. Both long and short OREX through a Feb 7x12 call/put strangle.