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How I am long and short DCTH for $0

|Includes: Delcath Systems, Inc. (DCTH)
Delcath is set to announce top-line data on Phase III results for their PHP system in “April.” The exact timing within the month of April is thus far uncertain.  From an option trader’s perspective, this creates an interesting multi-leg option trade (at least on the PUT side; the CALL side is more basic) as both April and May expiration options are potentially “in play” and thus implied volatility will be substantial for both series (for those not experienced in options, April 2010 options expire April 17; May 2010 options will thus trade for the remaining time in April until they expire May 22).  It should be noted that a large sum of money was made using the PUT side of this strategy (about to be described) with PARD back in November 2009…

Now back to the trade.  I initiated this trade in various sizes (during the past week).  The trade is in two parts (the second part, is optional). The table below includes the market prices of the options at the time of the trade(s). Here is the trade:

Part I: PUT Side
The goal of Part I was to enter the trade at a CREDIT.  Based on market prices at the time of the trade(s), it was possible to initiate the trade at approximately a 0.12 credit. Here is the math (for a 100 x 200 contract trade):

BUY 100 APRIL 5.0 strike PUT @ 0.24 ( = 100 x 100 x 0.24 = $2,400 DEBIT*)

SELL 200 MAY 2.5 strike PUT @ 0.18 ( = (200) x 100 x 0.18 = ($3,600) CREDIT)

Net Position = ($1,200) CREDIT

*For the uninitiated: DEBIT means you pay cash; CREDIT means you get cash.

Part II: CALL Side
In the second part of the trade (which is optional – hey, why not swing for the fences occasionally?), I use the proceeds from Part I to buy an April 12.5/15.0 strike Bull CALL spread.

Here is the trade:

BUY 100 APRIL 12.5 strike CALL @ 0.26 ( = 100 x 100 x 0.26 = $2,600 DEBIT)

SELL 100 APRIL 15.0 strike CALL @ 0.14 ( = (100) x 100 x 0.14 = ($1,400) CREDIT)

Net Position = $1,200 DEBIT

Total Position (i.e. PUT & CALL) initial P&L = $0

The total trade costs $0 (i.e. this trade is free excluding broker costs).  When results are announced, implied volatility, currently north of 250/300%, will collapse… substantially (based on historic vol charts, I would expect implied vol to collapse to around 100% if not lower). This will kill the option premium across the chains – i.e. values will collapse to near term expiration values).  If results are announced before April expiration (if only PUT side is established), the trade will show an immediate profit regardless of price direction. From my perspective, this is the fun part – no matter where the stock goes, I make money (however, because I used proceeds from Part I to fund Part II, the “profit” is that I will incur no loss; if I didn’t do this, the immediate (minimum) profit would be the $1,200 CREDIT).   For my multi-part position, maximum profit occurs around $2.50 on the PUT side and maximum profit occurs above $15 on the CALL side. 

Now the tricky part:  what happens when (if) results are announced after April expiration?  If this happens I am now short the May 2.5 strike PUT.  I basically have two options: (1) buy back the May PUT or (2) hold into the results. If I buy back the May PUT, my loss for the trade will be the total cost of the long April PUT and CALL positions less (or plus) any gain (loss) on the May PUT.  Not fun, but any further risk has been removed.  If I hold into results, I need either positive PIII results or, if negative results, I need DCTH to stay above $2.50 (a 72% drop from current levels).  Thus far, this type of downside move is not being priced into the options (however, it can still happen)…

Disclosure: Long and short DCTH options