Dendreon: Thinking Strategically Ahead of the FDA Review

| About: Dendreon Corporation (DNDN)

I wrote on November 3rd about Dendreon (NASDAQ:DNDN), a company trying to get Provenge approved as a treatment for hormone refractory prostate cancer [HRPC], that is, prostate cancer than doesn’t respond to standard therapy. It announced on January 16th that Provenge had been granted priority review status by the FDA.

According to the FDA, priority review is granted if: “The drug product, if approved, would be a significant improvement compared to marketed products [approved (if such is required), including non-"drug" products/therapies] in the treatment, diagnosis, or prevention of a disease.”

According to a January 2006 study by Booz Allen Hamilton, 62% of drugs with priority review received approval in the first cycle, compared with 34% of drugs that were subject to normal review. To be clear, the sample size in this study was small, a total of 77 applications, of which only 26 were priority review. As well, 62% is still far from a sure thing.

For example, for the week ending October 14, I wrote about Avanir Pharmaceuticals (NASDAQ:AVNR). Avanir’s drug Neurodex had priority designation. My suggestion was the drug would not be approved and that shorting AVNR was a good investment. In the end, Neurodex was not approved and AVNR, which was trading at almost $9 that week, is now at less than $1.50.

An FDA advisory panel will discuss Provenge on March 29th and issue recommendation for or against approval. While this doesn’t guarantee marketing approval (DNDN should hear about this on May 15), outcomes of these advisory board meetings are often good gauges of what the FDA will do.

Whether Provenge is approved or not is very speculative. Results of a Phase 3 study published in The Journal of Clinical Oncology last July showed that the difference in time to progression of the disease was statistically the same as a placebo, which is not encouraging. However, patients taking the drug lived, a statistically significant, 20% longer (3-5 months) than those receiving the placebo. So, I’m mildly bullish that this drug will be approved.
It should be mentioned that DNDN’s technicals are not favorable, and that short interest on this stock is 25%.

Clinically, Dendreon has nothing else going for it. One way or another this stock is going to move next week. A prudent approach to this can be an option straddle. Implied volatility on April options is well in excess of 250%, so a straddle with a $5 strike isn’t that favorable.

As I said, I am mildly bullish on this stock and I like to speculate. So, putting this together with a dose of prudence (I'm a chemist, not a fighter pilot), we end up with a bull spread: that is simultaneously buying a lower priced call option and selling a higher priced one. Mathematically, being both long and short derivatives of the same underlying equity reduces implied volatility and time decay. The use of spreads is a lower-risk/lower-reward position.

Looking at possible bull spreads for DNDN options, I like the combination of buying a 2.5 call and selling a 7.5 call. One of the nice aspects of using spreads is that time decay is greatly reduced: using Jan 08 options is not significantly more expensive than April options. The spread price (Jan 08 calls, long 2.5 short 7.5) at 11 AM Friday was $1.10. So, the maximum loss is $110 per contract and the maximum benefit is $390 per contract. As long as the price stays above $3.60 there shouldn’t be any loss. The 2.50/10 bull spread is also a good option. Open interest on both is fairly robust, and the bid-ask spread is ok.

To me given the uncertainty surrounding Provenge, this seems like a favorable trade, but not one that should be entered into without understanding the mechanics of the bull spread and that it is highly speculative. As such, I would not invest as much I normally would, and would not include this in the BC Tracking portfolio.


- Dendreon Interest Remains; Early Volume Surges
- Dendreon's Stock Activity Ahead of FDA Review

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