I last wrote an article on Arena Pharmaceuticals (ARNA) in mid May, soon after it spiked for a 73.4% gain. I saw a potential income opportunity after the spike. I made mention of Vivus (VVUS) which had a similar experience and continued to move. The original option play was buying a straight call option (July 2012 with a strike of '7') that was priced at $1.20 at the time. Since then, the company has continued to move up and is presently trading at $8.56. The original option from July is now selling at $1.99.
Here is how the trade panned out:
- Bought a July 2012 call with a strike of '7' (priced at $1.20) when the stock was trading at 6.36.
- Sold the July option (priced at $1.99) when the stock is trading at 8.56
- ($1.99 - $1.20)= $0.79
- Profit: $0.79
- ROI: 65.8%
The main reason the stock shot up like it did is because Cramer from Mad Money dubbed it a new favorite biotech stock. Mentioning the new weight loss drug in the pipeline, Cramer reasoned it should be a great revenue generator not just because it promotes weight loss but because people like spending money to look good. A key note for him was that the drug, in Phase III research, does not appear to have the side affects that some other weight loss drugs have.
If you are unfamiliar with the drug, the name is lorcaserin. Cramer sounded a bit overdramatic, as if this drug is the holy grail of weight loss. The FDA still had some concerns after approval about side effects with heart valves, but planned to have this issue looked at in post-approval studies. The weight loss was moderate at best but obesity is such a concern that extremely overweight people may be inclined to use it even though it is not considered an ideal drug, according to Dr Daniel Bessesen, chief of endocrinology at the Denver Health Medical Center.
Side affects for weight loss drugs are not uncommon. Xenical, produced by Roche (RHHBY), has side effects that occur usually after the first year: depression, leg pain, swollen feet, and tendonitis. Back in the spring of 2011 activists called for its ban from the markets because of growing side effect risks. They stated some major concerns, such as pancreatitis, liver damage and kidney stones.
I think the jump in Arena's stock may be a bit premature and emotionally based upon Cramer's viewpoint on the drug. Make no mistake; there are still concerns about Lorcaserin's side effects, even though they may not be as bad as some other weight loss alternatives. The panelists of the FDA who approved the drug did so with the admonition that patients should receive electrocardiograms to detect if they have any valve issues. The main issue still facing the drug is the risk of leaky heart valve for patients of the drug. An article by Matthew Herper from Forbes explains it well when he writes:
This medicine is a 5HT2c agonist, which means it trips one of same 5HT2 receptors that was blocked by an American Home Products drug called fenfluramine, which was pulled from the market because it caused heart valve problems… Based on the data, Sanjay Kaul of Cedars-Sinai Medical Center, a panelist who voted against the drug, said that the increase in the risk of heart valve problems seemed to be about 10% or 15% and a risk of up to 67% has not been ruled out.
He goes on the mention that the findings were inconclusive, so the risk has not yet sunk the drug.
Approval is supposed to come on June 27th possibly. If approval comes (and the market thinks so) then I would think the stock will rise again. But I am playing it a little more conservatively. I think we are going to get a correction so I am looking at a Bear Put Spread for July.
The Option Play
- Buy a July put with a strike of '8' (priced at $1.67)
- Sell a July put with a strike of '7' (priced at $1.13)
- Net Debit to Start: $0.54
- Maximum Profit: $0.46
- Maximum Risk: net debit
- Maximum Length of Trade: 1 month
I could be totally wrong on the correction and the fact that I think the new revenue for the stock initially is already factored into the price. I am playing Cramer's announcement and calculating a pullback based upon quick emotional buying.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.