Speculative Biotech: A Speculation Trader's Dream and Nightmare

Includes: BMTI, MNKD, PRTK
by: Spencer Knight

How can investors distinguish between which opportunities that should be fundamentally avoided, and those to accept with arms wide open? Is there some indication that informs investors which speculation plays to take and which to avoid?

These types of questions are difficult to answer. It becomes more complex when you discuss short positions and long positions. As you can see, in a matter of seconds the equities market can be perceived as a complex maze of ups and downs that are highly questionable (as David Van Knapp discussed in "Here's What Mr. Market Says: 'Ban Dividends'"). This should come as no surprise. What is surprising is how speculative biotech traders fall for the same tricks and gimmicks year in and year out.

Before I move on to show the trends biotech stocks follow, it is important to outline what speculative biotech means. Speculative biotech is the opening of a speculative position, long or short, in a biotech company that is in itself speculating on a new medical treatment. Additionally, speculative biotech companies place their livelihood in the hands of the FDA; which can arguably be more strict towards certain drug applications.

Now that we are, hopefully, in agreement of what speculative biotech trading is, I can present the patterns investors can use to identify a strong speculative investment and a weak investment decision. Keep in mind, if you properly identify a weak speculative stock, you can short the FDA's decision and collect profits.

The three companies below are examples of speculative biotech stocks for three important reasons. First, speculative biotech stocks face periods where the share price stabilizes between clinical trials results and / or FDA news. Secondly, speculative biotech stocks see sharp share price increases and decreases based upon the said clinical trials and / or FDA news. Lastly, speculative biotech companies focus upon one FDA approval of a potentially blockbuster treatment.

The three examples I will use that have been a nightmare for speculative biotech traders are Mannkind (NASDAQ:MNKD), Transcept Pharmaceuticals (TSPT) Biomimetic (NASDAQ:BMTI). It is important to note, if a stock is a long term nightmare, it is simultaneously a short trader's dream.

The first share price moving event to be discussed is clinical trials results. One of the first major share price movements related to clinical trials for Mannkind came on January 16, 2006 with the announcement of the phase 2b trial of Mannkind's Technosphere Insulin. The anticipation of this announcement, along with the results, gave traders a reason to send the share price nearly 72% higher from the January 3rd closing price.

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As expected, this same trend can be applied to BioMimetic between October 27th through November 4th of 2008. On the announcement of positive clinical results of Augment Injectable Bone Graft, the stock soared 85% over the six trading sessions listed above. This is the first example of point number two; which is that speculative biotech stocks surge or plunge based upon the results of clinical studies.

After these announcements, there was no worthwhile news or events to move each company's respective share price for nearly two years. Therefore, as point number one alludes to, the speculative biotech stock's share price will slide to a stable level during periods of no news. Sure enough, Mannkind's stock slid roughly 55% to a stable 5.00-6.00 range before the next major news announcement regarding Afrezza (at the time it was Afresa) was released. On the other hand BioMimetic's share price grew to the stable 14.00 level.

Another part of speculative biotech is clinical studies and announcements by competing companies or the FDA. Mannkind's share price took a hit on April 9, 2008 after Pfizer announced Exubera studies indicated 6 out of 4740 patients came down with lung cancer during the trials. To make matters worse, Exubera had a previous history of adverse effects related to pulmonary function prior to this announcement. This is important because Mannkind's speculative treatment is similar to Exubera, therefore investors and traders sold off and Mannkind's stock plunged 60% to 2.35 on April 9th.

Similarly to Mannkind's bad beat, BioMimetic suffered an unexpected FDA posting stating BioMimetic's Regranx may cause cancer and cancer deaths when used for at least 140 days consecutively. This illustrates the volatility speculative biotech stocks inherently carry, because at any given time clinical studies results can surface and trigger a massive sell off.

Another example of clinical trials results came on September 16, 2008 when Mannkind announced phase three results for Type 1 diabetes patients. As you can imagine, the results were positive because the share price jumped 49% over the next two trading sessions. More importantly, very shortly after this surge the share price slid back to the characteristic stabilization point. This reiterates the first important point speculative biotech stocks share; which is they fall into a stabilized range during periods without news or expectations.

The next and possibly most important pattern speculative biotech stocks make is the pre PDUFA date run. These types of trends occur over short term periods and long term periods. For instance, after Mannkind submitted the initial NDA for Afrezza, the share price soared 281% through September 22, 2009. Similarly, after Transcept filed Intermezzo's initial NDA, the share price soared an incredible 942% prior to the PDUFA date.

A less long term pattern can be viewed as well. Mannkind saw a pre PDUFA date run in January of 2010 of about 34%. Unfortunately for traders, the decision was delayed. The share price then followed the characteristic stabilization phase until March 15th, when the FDA sent Mannkind a CRL for Afrezza; citing more "clinical data to support the treatment's utility." The share price plunged 39% on the news.

Eerily similar to Mannkind's run, Transcept's share price moved up 32% within the final month prior to the PDUFA date. Unfortunately for the longs, Transcept received a CRL from the FDA with concerns regarding next day driving impairment. Because of this, the stock plunged 69% percent.

After each company's first CRL, both respective equities stabilized around 6.00 for Mannkind and 8.00 for Transcept. This again illustrates that the best time to buy speculative biotech stocks is during the months and sometimes years of no news, because the share price will remain stable.

Later in December 2010 Mannkind's share price made another pre PDUFA run of 36% prior to the expected PDUFA date of December 29th; which was again delayed until January 19, 2011. Prior to the new PDUFA date the stock made another 20% run from January 7th through January 18th. And it is well known Afrezza received a second CRL in January which caused the share price to plunge 45% over the next four sessions.

Unsurprisingly, Transcept's share price followed this same pattern and began to run above 11.00 prior to the July 2011 PDUFA date. Unfortunately on July 14th Transcept received another CRL with the same statements from the FDA. During the first two weeks of July Transcept's share price plunged 57%; giving short sellers another win over the longs in the saga behind Intermezzo.

As expected, Transcept submitted another NDA on September 27th which was given a PDUFA date of November 27, 2011. This is the perfect time to test the reader to see if you have been paying attention. Knowing the trends of speculative biotech companies, how has Transcept's share price reacted and how will it react prior to a PDUFA date less than a month away?

As expected, Transcept's share price has soared 195% since the company began appealing the FDA and requesting a Class 1 resubmission.

Another important event that causes the up and down cyclical pattern of speculative biotech stocks is the FDA Advisory Committee. BioMimetic faced an FDA Advisory Committee on May 12th and the stock plunged 35% on May 10th in anticipation of a negative report. It is important to note that the FDA officially gave a positive recommendation as the committee voted 12-6 in support of Augment Bone Graft with regards to safety; 10-8 in support of Augment Bone Graft with regards to efficacy; and 10-8 in support that Augment Bone Graft demonstrates higher benefits than risks.

Unfortunately, speculative biotech traders and investors do not like any kind of negative news. Therefore, if there are any signs of weakness, the stock will sell off, just as with BioMimetic.

By now the trends of speculative biotech should be clear. It is important to note, however, there are many stories of speculative longs becoming successful. However, this strategy of investing is not for everyone. In fact, this style of investing should only be used for a very minute portion of an overall portfolio.

The biggest problem with speculative trading is the countless stories of traders bringing in major profits and even making millions. These are the stories that bring speculative traders to the table. Fortunately, the above trends and cycles can be applied to future investment decisions. Furthermore, speculative biotech traders with less experience should be able to recognize and predict weak speculative biotech stocks and avoid losing big money.

I do not recommend short selling unless you have years of experience, but it can be a rewarding experience. I also do not recommend opening long positions in speculative biotech stocks unless you have nerves of steel and a short memory. A 40% plunge can be enough to force a long investor into trying over and over again until they get it right. And as I have shown above, sometimes this will never happen.

Before you go out and attempt to correctly predict a speculative biotech stock, please remember the three main points. First, since biotech stocks have a tendency to stabilize between a certain range during clinical trials when no news is close to surfacing; these are the periods to open a long position. However if the clinical trials produce inferior results to current treatments, or the treatment causes a worse medical issue, the stock will plunge.

Secondly, as alluded to in point one, you must be prepared for large share price increases on positive news and steeper decreases on negative news. These movements are how speculation traders make their money. Therefore news that may not sound bad, may in fact cause the share price to plunge because investors and traders sell in hoards and this can cause an avalanche of selling.

The final point to remember is that speculative biotech companies are also speculating about their own novel treatments. What makes a medical treatment speculative? First and foremost, it has to have the potential to be a blockbuster drug. A drug is considered blockbuster if it has the potential to change the way in which the healthcare industry treats a certain disease.

When all three of these points are true for a biotech stock, you have a speculative biotech stock on your hands. Therefore expect traders to be following these speculative biotech companies for any sign to short the stock or go long. You will not see me on the speculative trading field, but I will be watching for future trends and cycles to play out just as predicted.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.