A Biotech Moves Towards Profitability, and Offers a Possible Trade
Biotech companies can be among the most volatile stocks in the market. Often, this is due to test results. They need to complete an extended and arduous process to obtain Federal Drug Administration (FDA) approval of new drugs.
Many drugs never make it through the approval process. Others secure approval but fail to catch on in the market, perhaps because a new drug is introduced or because a drug has severe side effects that patients find worse than the disease.
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Neurocrine Biosciences Inc. (Nasdaq: NBIX) is a company that has been focusing on the problem of side effects. And, the results have been profitable for investors, so far.
The stock recently jumped after the company reported a second quarter revenue beat and a smaller than expected profit loss according to MarketWatch. The company reported a loss of $5.9 million in the latest quarter, or a loss of 7 cents per share, after a loss of $60.0 million, or a loss of 68 cents per share in the year-earlier period. The FactSet adjusted earnings-per-share consensus was a loss of 17 cents. Revenue rose to $96.9 million from $6.3 million, compared with the FactSet consensus of $83.7 million.
The company reported a loss of $5.9 million in the latest quarter, or a loss of $0.07 per share, after a loss of $60.0 million, or $0.68 cents per share in the same three months a year ago. The FactSet adjusted earnings per share consensus was a loss of $0.17.
Revenue rose to $96.9 million from $6.3 million, compared with the FactSet consensus of $83.7 million.
The revenue beat was made possible by what Chief Executive Kevin Gorman described as the “continued adoption of Ingrezza by physicians and patients,” referring to its drug for the rare condition tardive dyskinesia, whichcame to market last year.
Tardive dyskinesia or TD is a side effect of antipsychotic medications. These drugs are used to treat schizophrenia, bipolar disorder, and other brain conditions. Doctors also call them neuroleptic drugs.
These drugs block a brain chemical called dopamine. It helps cells talk to each other and makes the muscles move smoothly. When a patient has too little of it, their movements can become jerky and out of control.
Not everyone who takes an antipsychotic drug will get TD. But if it happens, it’s sometimes permanent.
TD causes stiff, jerky movements of a patient’s face and body that they can’t control. For example, a patient might blink their eyes, stick out their tongue, or wave their arms without meaning to do so.
Symptoms may appear after a patient takes an antipsychotic drug for an extended period of time, usually for 3 months or more. But there’ve been rare cases of it after a single dose of an antipsychotic medicine.
Older versions of these drugs are more likely to cause these movements than newer ones. Some studies find a similar risk from both types, though.
NBIX has another drug, an endometriosis therapy, Orilissa, that was also recently approved by the FDA. That could lead to additional gains in the stock which has been in an up trend for some time as the longer term chart below using weekly data shows.
However, buying after an extended run up in price presents significant risks to investors. An options strategy could provide a useful tool for investors who want to limit risk.
A Trade for Short Term Bulls
As with the ownership of any stock, buying NBIX could require a significant amount of capital and exposes the investor to standard risks of owning a stock.
To reduce the risks of a trade, an investor could purchase a call option. This allows them to benefit from upside moves in the stock while limiting risk to the amount paid for the options. However, buying a call option can also require a significant amount of capital and includes the risk of a 100% loss.
Whenever an option is bought, the maximum risk is always equal to 100% of the amount of spent to purchase the option. Since options cost significantly less than a stock, the risk in dollar terms will usually be relatively small to own an option.
To further limit the risks of the trade, an investor could use a bull call spread. This strategy consists of buying one call option and selling another at a higher strike price to help pay for the cost of buying the first call. The spread strategy always reduces the risk of an options trade.
This strategy is designed to profit from a gain in the underlying stock’s price but has the benefit of avoiding the large up-front capital outlay and downside risk of outright stock ownership. The potential risks and rewards of this strategy are summarized in the chart below.
Source: The Options Industry Council
Both the potential profit and loss for the bull call spread are limited. The maximum loss is equal to the net premium paid when the trade is opened. The maximum profit is limited to the difference between the strike prices, less the debit paid to put on the position.
This strategy could be especially appealing with high prices stocks where the share price and options premiums are often a significant commitment of capital for smaller investors.
A Specific Trade for NBIX
For NBIX, the August 17 options allow a trader to gain exposure to the stock.
An August 17 $115 call option can be bought for about $2.50 and the August 17 $120 call could be sold for about $1.20. This trade would cost $1.30 to open, or $130 since each contract covers 100 shares of stock.
The amount paid to enter the trade is the largest possible loss on the trade. This is generally true whenever a trader is creating a debit to enter an options trade. “Creating a debit” means there is a cost to enter the trade. You could create a debit by simply buying puts or calls to open a directional trade.
In this trade, the maximum loss would be equal to the amount spent to open the trade, or $130.
The maximum gain on the trade is equal to the difference in exercise prices less the amount of the premium paid to open the trade.
For this trade in NBIX the maximum gain is $3.70 ($120 – $115 = $5.00; $5.00 – $1.30 = $3.70). This represents $370 per contract since each contract covers 100 shares.
Most brokers will require minimum trading capital equal to the risk on the trade, or $130 to open this trade.
That is a potential gain of about 180% based on the amount risked in the trade. The trade could be closed early if the maximum gain is realized before the options expire.
In this trade, options provide income and defined risk. These are the type of strategies that are explained and used in TradingTips.com’s Extreme Profits Calendar service. This service uses seasonals as one indicator in its trade selection process. To learn more about how options can be used to meet your goals, click here for details on Extreme Profits Calendar.