Drug Problems Spark Contrarian Reactions for Genentech, Merck

A drug failure sparked a quick contrarian reaction to Genentech (DNA). Shares in Genentech dove 6% to $68.35 on news that its drug Rituxan, developed in cooperation with Biogen Idec (BIIB), failed against a placebo in Phase II/III clinical studies involving late-stage lupus patients. Options in Genentech are trading at their heaviest volume since February 25, with more than twice as many calls trading as puts. Implied volatility at 30% shows a moderate elevation about the 27%.

The contrarian follow-through we’re seeing in the option market appears to be in siding with an Oppenheimer analyst note on Genentech immediately following news of the trial failure, which indicated that sales estimates for Rituxan as a treatment for Lupus were not included in Genentech’s guidance and maintained a ‘buy’ rating on the shares. This would explain the heightened level of call-buying we observed in Genentech’s May contract at strikes 70, 75 and particularly 80 – this latter strike in excess of its 15,000-lot open interest – and selling in puts at strikes of 65 and 70 as the share price decline made these positions double in value. Similar positioning was observed in the June contract, with heavy buying in call strikes as high as 80 and selling in the puts.

Merck (MRK) shares tanked more than 10% to $37.15 (within 50 cents of its 52-week high) following an FDA rejection of its pipeline cholesterol drug Cordaptive, a drug that has already been approved by EU regulators for sale in Europe. Option traders swiftly put some 90,000 contracts in play, with selling pressure noted in May 40 calls and 37.50 puts.

It is possible that some of this volume is occurring in tandem, in so-called short strangles that would suggest a quick floor being put under Merck’s speedy decline as shares remain rangebound between the two strike prices. The current 30% implied volatility reading indicates the option market pricing in less risk to Merck shares than is already apparent in the 52% historic reading – Merck shares have traded as high as $61.24 over the past year.

Comments

[afarhat]

the third paragraph of this article states that merck shares tanked at $37.15, then made the comment "within $.50 of its 52 week high." seems to me that merck was selling above $60 not that long ago. looks like some proofing would be in order.

[User 7888]

andrew do you have subscription web site?

[OptionTrader]

Interesting. cgi.ebay.com/ws/eBayISAPI.dll?ViewItem&a...