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Last week Discovery Laboratories (NASDAQ:DSCO) received the news that its drug, Surfaxin, had at last been granted marketing approval by the FDA. Certainly good news for investors - but how good? DSCO closed at $3.75 on Tuesday, prior to the announcement. On Wednesday the stock opened at $5.25, moved to $5.39 and then collapsed to $4.08. So an investor would have enjoyed a 1-day return between 9% and 44% depending on when (s)he sold. The stock is currently trading at ~$3.40, well below the close prior to the news.


(Click to enlarge)

This is certainly an example of the adage "Buy the rumor, sell the news". In the 3 months prior to approval DSCO had a great run from a low of ~$1.50 to a high of ~$3.80. Following its previous 4 failed attempts to secure approval, the market clearly believed that the fifth time would be successful. And the market was right. However, once the inital excitement of the approval wore off (quite quickly) investors turned to assessments of Surfaxin's market size and the comany's ability to commercialize the drug.

Watching the DSCO price last week I wondered whether it would be possible to validate the "sell the news" advice in small-cap biotechs. These stocks generally move aggressively on news and are unusually focused on a small number of product prospects. I thought it would be interesting to look at the price action of companies that received positive news from the FDA in the days after the approval.

Data used

I looked at the prices of small biotechs (market cap <$1B) that received approvals since the start of 2011. I did not include label extensions. I also excluded companies that received an approval ahead of the scheduled PDUFA date (for instance, Curis (NASDAQ:CRIS)).

The following 12 companies and decisions were included in the analysis

Company Drug Approval date
Discovery Labs Surfaxin 3/7/16
Corcept Therapeutics (NASDAQ:CORT) Corlux 2/18/16
BioSante Pharmaceuticals (BPAX) Bio-T-Gel 2/15/16
Antares Pharmaceuticals (AIS) Anturol 12/8/11
Transcept Pharmaceuticals (TSPT) Intermezzo 11/23/11
Repligen (NASDAQ:RGEN) Aflibercept 11/18/11
IntelGenx (OTCQX:IGXT) CPI-300 11/13/11
Pacira Pharmaceuticals (NASDAQ:PCRX) Exparel 10/28/11
Acura Pharmaceuticals (NASDAQ:ACUR) Acurox 6/17/11
Optimer Pharmaceuticals (NASDAQ:OPTR) Fidaxomicin 5/30/11
Xenoport (NASDAQ:XNPT) Horizant 4/6/11
Depomed (NASDAQ:DEPO) DM-1796 1/30/11

In order to assess the stock move post approval I looked at the returns from the following strategy:

  1. Short the stock at the first open after the news release. If the approval announcement is after hours or intra-day, sell at the open the next day. If the approval comes pre-market, sell at the open the same day.
  2. Buy back at the close on subsequent days. I tested same day to 5 days after.

Note that I am not advocating this as an automatic strategy. It is hypothetical and not forward tested. It depends upon buying at the opening price and selling at the closing price - a requirement that may not be possible in practice.

Results

Based on the analysis the following are the back-tested results of this strategy.

Days held

1

2

3

5

Number of trades

12

12

12

11

Winners

10

10

9

8

Losers

2

2

3

3

Average return

9.61%

12.89%

13.80%

14.24%

Average win

12.56%

16.65%

19.95%

23.90%

Largest win

30.12%

36.65%

39.29%

36.67%

Average loss

-5.10%

-5.89%

-4.63%

-11.54%

Largest loss

-5.91%

-6.23%

-9.76%

-17.29%

These results illustrate that, based on recent trends, selling the news of an FDA approval is consistently the right approach (at least in the short term) in the small-cap biotech setting.

Implications:

There are several companies facing high profile FDA decisions coming up in the next 6 weeks including Affymax (OTCPK:AFFY), Chelsea Therapeutics (NASDAQ:CHTP), Map Pharmaceuticals (NASDAQ:MAPP) and Vivus (NASDAQ:VVUS). While VVUS's market cap exceeds that if the test group, the analysis might be worth bearing in mind around its decision point.

While this analysis is based on a small set of data points, there are some take-aways that I will be thinking about as I trade around these and other FDA decisions this year:

  1. Do not buy at the open after an approval. If you are planning on holding for some time you will probably be able to get a better price if you wait.
  2. If you hold through the approval, selling quickly may be the best approach. If you want to hold for the long-term you may be able to re-enter at a better price.
Source: Should You 'Sell The News' In Biotech Stocks?