This morning, Vertex Pharmaceuticals (NASDAQ:VRTX) announced positive results for phase 3 clinical trials. As a result, the stock soared 50%+ pre-market, surpassing $100 for the first time in the firm's history. Of course, an unsuccessful outcome would have resulted in an extraordinary move in the opposite direction; clinical trial outcomes such as these present extreme binary events to investors.
In late February, 2014, a structured note was issued with roughly $20 Million in notional on VRTX. As I wrote in my blog post on binary events as well as an earlier article in Seeking Alpha, this structured note presented investors with two unattractive outcomes - if the VRTX clinical trial was successful, the stock would appreciate significantly and the structured note would be called early and investor returns would be capped at a modest 5.5% yield (about 11% annualized). If the trial was unsuccessful, the stock would take a substantial hit, perhaps substantial enough to eliminate any principal protection and thus expose investors to a major loss.
Since VRTX is now well above the issuance price of $84.81, the note is due to be called August 21. Investors will receive their principal back at that time, resulting in a grand 5.5% total return over 6 months. In contrast, as of this morning's opening, VRTX was up 15.6% as compared to the price when the structured note was launched; thus, investors who owned VRTX outright will finish considerably ahead of owners of the structured note.
In conclusion, the structured note I analyzed offered a tantalizing annualized yield, but exposed investors to a major potential loss with limited upside. If investors plan to pursue investing in binary events, they might want to consider solutions which better balance the risk-reward tradeoff.
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it. The author has no business relationship with any company whose stock is mentioned in this article.