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Binary/Option Play on BIOD

|Includes: Albireo Pharma, Inc. (ALBO)

 My trade of the day involves one of my favorite strategies in biotech investing, the run-up method, coupled with an option play that exploits the time frame of the run-up strategy. While perusing the companies with upcoming October PDUFA  dates along with options expiring in September I came across this buy-write option play on Biodel (BIOD):

Buy BIOD currently at $3.62. Sell call option for $5 strike price expiring September 18. Call contract bid price is currently at $0.35/share.

So what are the possible outcomes of this trade?

BIOD goes above $5 before September 18 - $1.38 capital gain + $0.35 option contract per share minus transaction costs. Up to 48% profit.
BIOD goes up but doesn't reach $5 - You hold the shares for a few more weeks and sell into the run-up to the October 30 PDUFA date for VIAJect. This actually has the highest potential for big gains. The strategy is then to hold the shares until some time before the PDUFA date - typically 2-4 weeks and sell into the influx of buyers from speculation and increased news coverage.
BIOD goes down - Obviously your downside is protected by ~10% due to the option contract. While I expect this stock to be relatively volatile, I don't see any price-tanking news events taking place. The NDA for VIAJect has been submitted and no news, good or bad, is likely to be generated with respect to this product. In addition, with a market cap of $88 million and a pipeline containing no drugs beyond phase 1 trials, much of the value of the company appears to be riding on the success of VIAJect. Furthermore, BIOD is trading at the lower end of its 52 week range and I find it hard to believe it will go much lower with the high potential profits of its VIAJect product.

In addition, I always like to make sure the underlying company is in top notch shape and that the drug has potential to be something analysts and pundits will be talking a lot about on the way to the binary event. How are we doing in this department?

Here is the information on VIAJect from Biodel:

Our lead clinical candidate is VIAject™, a very rapid-acting form of injectable human insulin for meal-time use by patients with Type 1 or Type 2 diabetes. VIAject™ is comprised of commercially available recombinant human insulin and our proprietary formulation of ingredients, all of which are Generally Regarded As Safe (OTCPK:GRAS) by the FDA. Our proprietary formulation delivers insulin in a form which more closely resembles the way a normal body uses insulin to help glucose enter the body's cells, providing energy that allows the body to function. Currently, insulin therapies are not delivered quickly enough to simulate the desired meal-time insulin spike. In tests to date, the VIAject™ formulation of insulin promotes a more rapid absorption, which more closely mirrors the effects of naturally produced insulin in non-diabetics thereby providing more effective blood glucose control. This novel therapy is currently undergoing two pivotal Phase III clinical studies. The two studies, one involving 400 patients with Type 1 diabetes and the other involving 400 patients with Type 2 diabetes, are comparing the effects of VIAject™ to Humulin®, the leading recombinant human insulin.

Basically, from my understanding they take regular insulin - which typically exists as a heximer (see here) - and treats it with EDTA and a buffer system to break the insulin into its monomer components. The benefits of the monomeric insulin appear to be 1) more rapid and more stable insulin response 2) lower incidence of hypoglycemia and 3) lower risk of weight gained compared to standard Humulin insulin injections. While it is hard to determine what premium Biodel will be able to charge for their treatment, the EDTA and buffer treatment should not impart any significant cost on Biodel's end, so Biodel should not need a significant premium to recoup costs and land itself a sizable profit.

So the product itself looks good. What else?

Big market potential? Check. With 23.6 million diabetics in the US, the potential market is huge. A small percentage of the injectable insulin market equals big revenues for this $88 million market cap company.
Favorable analyst coverage? Check. Six analysts are covering the stock with an average 'Strong Buy' rating.
Low share price and market cap? Check and check. This makes things a little more on the volatile side but that's good if you're looking for that nice 48% profit on the call option (or even more during the run-up!).

In summary, this trade offers a good entry into the run-up method while providing a tremendous option premium if you aren't too greedy (or maybe you are greedy but betting on the bulk of the run-up occurring after the September expiration date!).

Disclosure: Long BIOD