Vivus (VVUS) is a biotech company that recently received preliminary approval from the FDA for the obesity drug Qnexa. Qnexa is a controlled release formulation of two existing drugs topiramate and phentermine. The focus of this article will be an option strategy that doesn't depend on choosing correctly whether the security appreciates or declines after the decision. All that is necessary is for the move to be sufficiently volatile enough to profit.
The option strategy that will be used for this situation is a straddle. A straddle is when a strategist purchases a put and a call at the same strike price. The strategist is hoping that the underlying move in the security is greater than the premium paid for the contracts. The contracts that I will be highlighting for this strategy are the June 2012 20 strike straddle.
VVUS Jun12 20 Call
Above is for the VVUS 20 strike call courtesy of OptionsXpress
VVUS Jun12 20 Put
This is the detailed quote for the VVUS 20 strike put. Price of security was 20.05 as of the close on 3/14/2012.
As we can see from the above quotes to enter into the straddle it would cost $9 per contract. To make a profit on this trade the underlying security would have to move either up or down by 9 points or roughly 45%.
In my opinion if the FDA does grant final approval especially without demanding further safety trials the security will easily move 50% netting a profit on the position. The reverse is also true as well. If the FDA rejects the drug VVUS will crater below $10 on the disappointment. The risk to this trade would be if VVUS fails to move 45% on the announcement.
The June strike was chosen instead of the April due to the relatively less expensive option. The implied volatility on the April contract was over 140% meaning the premium paid for the option is greater than the June which is 113%. The June option also gives the strategy extra time to unfold in case the initial move isn't sufficient to produce a profit. I believe the decision will be an "all or nothing event" where the move will be sudden and swift after the FDA decision.
Straddles tend to work best before a major announcement such as earnings or a drug approval. The best time to initiate a position would be closer to the event date so the price doesn't wander too much above or below your strike. Ideally you want to enter the position a few days before the announcement right at your targeted strike price.
Additional disclosure: Thanks for reading. VVUS is a very volatile stock and should be monitored closely. The above article is a way to profit on the expected move without having to guess correctly. The above article was for informational purposes only and I look forward to your comments.