Federal Drug Administration approvals have a big impact on the stock prices of small pharmaceutical companies. The small pharma companies may have their entire business riding on one drug as they try to break through the FDA approval barrier on the road to market their products. Typically, the stocks of these companies run up a few months prior to the FDA decision date. Once the decision is made, the stocks of these pharma companies either take a jump higher upon FDA approval or will take a deep cut lower upon an FDA rejection. Take a look at the table below and see how you can profit from these events.
Keep in mind that these dates are not always exact – the approvals could happen a few days or weeks before or after the stated date. For example, Alexion Pharmaceuticals (ALXN) had an FDA decision date originally scheduled for Oct. 7, 2011, for Soliris, but it was approved early on Sept 23, 2011.
Strategies – Keep in mind these are risky stocks, so only use money you can afford to lose.
The simplest way to play these potential FDA approvals is to buy the stock a few months prior to the FDA decision date - since the stocks typically run higher in anticipation of the date. Then sell the stock prior to the decision, so you don’t lose your investment in the case of a rejection. This can be risky if the FDA unexpectedly rejects the drug earlier than the decision date. On the other hand, you may be pleasantly surprised with an extra stock bounce if the FDA approves the drug early.
Since some of these stocks have pending approval dates in a few weeks, you could try an options trading strategy known as a straddle. By implementing a straddle, you would simultaneously buy a call option and a put option of the same strike price prior to the decision date. If the drug is rejected, the put option should rise in price and the call option should lose most of its value. If the drug is approved, the call option will rise in value and the put option should lose most of its value. The idea is that the move on one side will offset the loss of the other, yielding you a profit. However, sometimes the stock price does not move enough and you can lose money on the trade.
You can also just buy the stock and hold it through the decision. If you get an approval – congratulations, you should have a nice profit. If the drug is rejected, be prepared to lose a large portion of your investment.
The riskiness of these stocks is what makes them exciting. I just want to reiterate that you should only use an amount of money that you can afford to lose. Also, be aware that some of these companies do not have stock options available.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.