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In March I wrote an article investigating the "sell the news" effect in small biotech stocks. The news in question was the announcement of an FDA approval for an investigational drug. At the time I reviewed the relevant approvals from 2011 and early 2012. The article reviewed the profitability of the following simple 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.

The analysis demonstrated a positive expectancy with between 10 and 8 winning trades (based on selling at the close from 1 to 5 days after the release of the news) and an expected return of between 9.6% and 14.2% per trade.

Since that article was published there have been three additional data points so I thought it would be worthwhile to reassess the validity of this approach.

Affymax (OTCPK:AFFY)

On March 27, AFFY announced that its anemia drug, Omontys, was approved for the treatment of anemia due to chronic kidney disease in dialysis patients. Ahead of the announcement the stock price enjoyed an impressive run from $6.35 on January 4, to $13.73 on March 26.

Following this approach would have suggested shorting at the open on March 28, and selling at the close on one of the following five days.

(click charts to enlarge)

The potential returns from the strategy are as follows:

Holding period (days)12345
Returns7.3%10.9%17.2%14.3%15.9%

Vivus (NASDAQ:VVUS)

On April 27th, VVUS announced that its erectile dysfunction drug, Stendra, had been approved by the FDA. The recent news for this company has been dominated by its obesity drug, Qnexa, which is facing its own decision point in July (pushed back from an original PDUFA date in April). Given that, one might not have expected significant gains based on this event.

Following the outlined approach would have suggested shorting at the open on March 28, and selling at the close on one of the following five days.

The potential returns from the strategy are as follows:

Holding period (days)12345
Returns4.9%5.1%4.2%7%9.2%

Protalix Biotherapeutics (NYSEMKT:PLX)

Protalix announced that its drug for Gaucher's Disease, Elelyso, was approved by the FDA on May 1. The stock had run from $5 in early January to as high as $7.33 in the days prior to the approval. On May 1, ahead of the news, the stock traded down sharply hitting a low of $5.80 and closing at $6.19 (down 9% from the previous day's close).

Following the outlined approach would have suggested shorting at the open on May 2, and selling at the close on one of the following five days.

The potential returns from the strategy are as follows:

Holding period (days)12345
Returns7.8%11.5%9.6%8.7%

Conclusion

With the above results included, the performance of this strategy since January 2011 is now as follows:

Days held

1

2

3

5

Number of trades

15

15

15

15

Winners

13

13

12

9

Losers

2

2

3

3

Average return

9%

12.1%

13.1%

15.4%

Average win

11.2%

14.9%

17.5%

23.9%

Largest win

30.1%

36.7%

39.3%

36.7%

Average loss

-5.1%

-5.9%

-4.6%

-11.5%

Largest loss

-5.9%

-6.2%

-9.8%

-17.3%

Several companies have PDUFA coming up in the near term. These include Xenoport (NASDAQ:XNPT), Repligen (NASDAQ:RGEN), Arna (NASDAQ:ARNA) and Amarin (NASDAQ:AMRN). If an investor owns stock in one of these and decides to hold through an approval, this analysis suggests that selling quickly after the decision is announced may offer an opportunity to re-enter at a lower price. Additionally, if it is possible to find shares to short, there may be some short-term potential in selling short immediately after the approval.

Source: Selling An FDA Approval: Recent Results