Without a doubt, Dendreon (DNDN) is one of the most controversial stocks in the market today. It seems that not a day goes by without a fierce debate over Provenge, its efficacy, and its future place in the prostate cancer market.
Over the past year, Dendreon has suffered mightily, with the stock falling almost 82% as Provenge forecasts were cut and investors and analysts question the drug's role in treating prostate cancer going forward.
But with a new CEO, John Johnson (appointed in February) and a turnaround plan in motion, could things finally be looking up for Dendreon? The market will soon be able to get a plethora of new information regarding Provenge and its place in the prostate cancer market. We believe that options can be used to substantially minimize the risk of investing in Dendreon, and outline our trade below. But first, an overview of the catalyst is needed.
ASCO 2012: Woodstock for Biotech Investors
Just as Berkshire Hathaway's annual shareholder meeting is seen as the "Woodstock for Capitalists," the annual meeting of the American Society for Clinical Oncology is seen by many market observers as the main biotechnology event of the year. Dozens of companies are set to present data on their newest oncology drugs, and fortunes will be made and lost based on what each company says (or doesn't say).
Dendreon will be presenting data from 4 abstracts and studies on Provenge at ASCO 2012 on June 3 and June 4. One is from a Phase III IMPACT trial regarding "overall survival (OS) benefit with Sipuleucel-T by Baseline PSA." A second is from a Phase II NeoACT study, which is designed to evaluate "immune activation following neoadjuvant Sipuleucel-T in subjects with localized prostate cancer." As a note, Provenge is not currently indicated for neoadjuvant treatment of localized prostate cancer.
Dendreon's stock is among the most volatile in the market, with a beta of 3.74. Depending on the data, the stock is likely to move sharply in either direction. But there is another factor that must not be overlooked when it comes to Dendreon and Provenge: competition.
Both Johnson & Johnson (JNJ) and Medivation (MDVN) will be presenting data on their own prostate cancer drugs at ASCO 2012. Johnson & Johnson will be presenting data from 4 studies of Zytiga on June 2 and June 4. And Medivation, which has filed for FDA approval of Enzalutamide (MDV3100) on May 21, is slated to present data from 6 abstracts and studies involving Enzalutamide (3 of the studies, however, are for breast cancer, not prostate cancer, and will therefore likely have little direct relevance to Dendreon and Provenge). Given the skepticism that abounds in the markets about Provenge, it is likely that what Johnson & Johnson and Medivation have to say will be just as important as what Dendreon presents (whether or not this skepticism is valid goes beyond the scope of our article). Dendreon's stock is almost certain to move sharply based on what these 3 companies say regarding their prostate cancer treatments. We however, believe that risk can be greatly minimized using options.
Protective Puts: Minimizing Risk, With a Caveat
Our options trade for hedging the data set to be released at ASCO 2012 involves put options. But before we continue, we must outline the rationale behind this trade.
This trade is based on our expectations of a large price swing in Dendreon, and has little to do with the underlying safety and efficacy profiles of Provenge, Zytiga, or Enzalutamide. We are not making a judgment call on which of these 3 drugs is the superior one in this article. Investors who have firm convictions about the superiority of one of these drugs versus another drugs should invest accordingly. For us, this is a short-term trade based on the likelihood of a large move in Dendreon's stock price and our desire to minimize downside risk.
Our trade involves buying upside June 16 puts in Dendreon. For the record, the stock closed at $7.22 on May 24. We break down the costs and benefits of this trade at various strike prices below. Data is accurate as of the close of trading on May 24, 2012.
|Net Cost Per Share||$8.40||$9.32||$10.13||$11.17|
|Decreased Downside Range||$8-$8.40||$9-$9.32||$10-$10.13||$11-$11.17|
|Upside Move Needed for Profits (%)||$1.18 (16.34%)||$2.10 (29.09%)||$2.91 (40.30%)||$3.95 (54.71%)|
Based on current prices, we believe that this trade is best executed using the $8 put. While it has the most downside of all 4 possibilities, it also requires the smallest upside move in the stock to be profitable. We think maximum downside of 5% versus 3.56% or 1.3% is a worthwhile tradeoff when the upside move needed for profitability is just over 16%, compared to 29% or 40%.
Should Dendreon shares plunge because of either poor Provenge data or concerns over positive data from Medivation or Johnson & Johnson, investors are protected from most of that plunge, and will lose just 5% using the $8 put.
Conversely, if Dendreon reports positive data, or Medivation/Johnson & Johnson fail to impress with their own data, the stock will likely soar. Investors will profit if the stock moves past $8.40, which represents an upside move of at least 16.34%. Given Dendreon's very high beta, as well as the large short interest in the stock [as of April 30, 32,948,418 shares of Dendreon were sold short, according to NASDAQ data. Based on Dendreon's 153,903,909 outstanding shares (per the company's latest 10-Q filing), this means that 21.41% of the company's shares are sold short] Dendreon's shares should be able to easily rally at least 16.64% on the back of positive news, as well as a possible short squeeze in the stock, given that over a fifth of the company is sold short. Medivation, by contrast has only around 8% of its shares sold short.
There are 3 possible outcomes by the put's expirations for investors who initiate this trade. Should the stock trade anywhere below $8, losses are capped at 5%. Between $8 and $8.40, losses are smaller. And should the stock rally past $8.40, which we feel is a distinct possibility if everything lines up in Dendreon's favor, investors will profit.
This trade should not be seen as a commentary on the safety or efficacy of Provenge, or its superiority/inferiority versus Zytiga and Enzalutamide. This trade is meant to hedge the risk of Dendreon having a poor showing at ASCO by minimizing the potential downside to just 5%. Investors wishing to express a more bullish opinion on Dendreon would be better off buying the stock outright, or purchasing call options. Dendreon's chart has shown the stock is quite sensitive to changing perceptions of Provenge's market potential. And at ASCO 2012, it is likely that perception of Provenge will change once again, for better or worse. For investors who do not have the necessary levels of risk tolerance to invest in Dendreon outright, this options trade cuts risk to what we feel is an acceptable level, while still giving investors an opportunity to profit should Dendreon see positive developments emerge at ASCO 2012.
Additional disclosure: We are long June 16 $8 DNDN puts in addition to DNDN. We are long JNJ via our holdings of the SPDR Dow Jones Industrial Average ETF.