Human Genome Sciences Options Prior to the FDA Decision

Mar. 8.11 | About: GlaxoSmithKline (GSK)

The FDA is expected to rule on Benlysta this week. If the FDA approves Benlysta as per the recommendation of the advisory board, it will be the first new drug to treat systemic lupus erythematosus in half a century. And sales will be at least in the billion dollar range, if not more. Approval will lead the stock to skyrocket, and the company may even be bought out. However, the FDA is known to be unpredictable, not always following the advice of its advisory board. Given that background, what are the ways to invest in Human Genome Sciences (HGSI) while decreasing risk?

1. Buy the stock, and sell covered calls. This will decrease the risk a bit, but will also decrease the potential upside. If the stock tanks, you will still be left holding the bag, while collecting the relatively small premium of the covered call. In addition, if the stock really takes off, your upside is limited by the call sold. Probably the worst strategy.

2. Buy the stock, and buy March puts. A good way to mitigate risk. If the stock soars, you lose the puts, but more than make up in stock appreciation. If the stock tanks, the puts provide protection, especially if in the money.

3. Buy puts and calls. This strategy has a high potential of making money, while not shelling out as much money as in strategy 2, especially if out of the money. The risks are if for some reason the FDA's decision (such as postponing the decision again) leads to a collective yawn, and the stock does not move in any direction. Another risk is that once the decision is out, volatility will plunge, and options will decrease in price.

4. Vertical spreads. This strategy overcomes the issue of plunging volatility. Here one buys and sells both calls and puts. For example, one can buy March 30 call and sell the March 35 call. Similarly, one can buy the March 20 puts while selling March 15 puts. This provides profits irrespective of which way the stock moves, while mitigating the decrease in volatility as well as time premium. On the other hand, it also limits the profits.

Just some strategies to consider on this very important upcoming decision.

Disclosure: I am long HGSI calls and puts