Using Options To Benefit From The Binary Nature Of FDA Decisions

by: David Anber

Although most portfolios have at least one steady, dividend paying biotech stock such as Pfizer (NYSE:PFE), Abbott Labs (NYSE:ABT), Bristol Myers (NYSE:BMY), Merck (NYSE:MRK), etc., using biotech to speculate is also not uncommon.

One of the reasons that biotech is fertile soil in which to plant such speculation is that the FDA gets to make significant decisions which often see these stocks rise or fall double digit percentages in a single session. This makes speculating on such stocks risky.

However, the binary nature of FDA decisions can provide us with opportunities to mitigate the risk.

One strategy which I have employed in the past is to simultaneously purchase a call and put option on the premise that the stock will likely move significantly one way or another once the FDA rules.

I have taken 5 stocks with upcoming FDA decisions which offer options; MDVN, ALXA, BIIB, SNTS and IPXL.

click to enlarge image

Click to enlarge
As you see, from the chart, each stock has a different profile with variables such as Beta, distance from Call or Put strike and recent trading range distinguishing one from the other. The purpose of this article is not to look in depth at each of the differences but rather to provide you with the framework for deploying this options strategy. As always, you should be selective and find the positions that fit your portfolio best.

Like a baseball player, you're not necessarily looking to hit a homerun all the time. Not every stock will pop or drop to your strike price. There is always the possibility of the FDA delaying its decision which could have the underlyin stock continue to trade sideways. Buying a later dated option is always a possibility but then you'll be paying for extra time value which would likely reduce the value of this strategy. But you'll find that even if the stock doesn't move to the strike, you can still sell the option for a small gain.

Using my examples, you'll need either your put or call option to increase in value to the following price in order to break even.

  • MDVN $0.97 Within the next 1 month
  • ALXA $2.95 Within the next 2 months
  • BIIB $3.05 Within the next 3 months
  • SNTS $2.00 Within the next 4 months
  • IPXL $2.45 Within the next 5 months

Lastly, a variant of this strategy can be accomplished through converting your options into spreads to reduce your premium cost further. As always though, you'll be capping your upside.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in ALXA, SNTS over the next 72 hours. (When I say I may initiate a long position in the stated positions, I mean that I may deploy the strategy described in this article.) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.