A Great Company Might Not Be a Great Stock
Source: Clovis Oncology
As traders, it is important to remember that we buy and sell stocks, or options on stocks. This is different than investing in companies. An investor in a company will look for a great company. A trader will simply look for a stock that can move quickly.
Sometimes, the difference between the stock and the company jumps off the page. That seems to be the case with Clovis Oncology, Inc. (NASDAQ: CLVS).
It appears to be a great company. Clovis is collaborating with Bristol-Myers Squibb Co. (NYSE: BMY) to evaluate the combination of Bristol-Myers’ s immunotherapy Opdivo and Clovis’ poly (ADP-ribose) polymerase (PARP) inhibitor Rubraca in Phase 3 studies in advanced ovarian cancer and advanced triple-negative breast cancers.
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The collaboration will include a Phase 2 study of Opdivo in tandem with Rubraca in patients with metastatic castration-resistant prostate cancer.
Good News May Be Priced In
According to the company, the phase 3 study demonstrated that Rubraca improved progression-free survival for each of three patient populations studied, meeting primary and secondary endpoints in the 564-patient trial. Rubraca significantly outperformed a placebo for each group in the study.
Clovis plans to submit its data to the FDA within four months, aiming for an expansion of the prescribed use of Rubraca into second-line and later maintenance treatment for ovarian cancer patients. Currently, Rubraca is only approved to treat ovarian cancer patients who have the BRCA gene mutation and who’ve already had two or more chemotherapies.
Rubraca is also under review in Europe and Clovis is setting up an organization there to support a potential launch early next year.
When Rubraca was approved in December, Clovis announced a price of $6,870 for a 15-day supply, or $13,740 for a month. This is slightly above the price of competitive products from Tesaro and AstraZeneca. Prices for those drugs are $9,833 for a month and $12,450 per month.
This is all expected to help the company turn profitable in 2020. But, the stock has been weak and sold off sharply on Monday.
The weakness is due to the company’s need for more funds. Clovis intends to sell up to $230 million in convertible senior notes due in 2025. The interest rate, conversion rate and other terms of the notes will be determined at the time of pricing of the offering of the notes.
Clovis also intends to sell another $100 million of shares of its common stock in an underwritten registered public offering. The underwriters will have a 30-day option to purchase up to an additional $15 million of shares of its common stock on the same terms and conditions.
The money will be used for general corporate purposes, including sales and marketing expenses associated with Rubraca® (rucaparib) in the United States and, if approved by the European Commission, in Europe, funding of its development programs, general and administrative expenses, acquisition or licensing of additional product candidates or businesses and working capital.
In the short run, with so much new stock being added to the marker, there is unlikely to be a significant rally in CLVS. It will take time for traders to gain confidence that the company is recovering from its problems. That creates a trading opportunity.
A Trading Strategy While Awaiting Better News
To benefit from the expected weakness in the stock, an investor could buy put options. But, high prices on put options suggests an alternative trading strategy. The option premium is high because the expected volatility of the stock is high. Options that are based on selling an option can benefit from high volatility.
In this case, with a bearish outlook, a call option should be sold.
Selling options can involve a great deal of risk. A spread options strategy can be used to limit the potential risk of the trade.
One strategy that is important to consider is the bear call spread. This trade uses two calls with the same expiration date but different exercise prices. Traders buy one call and sell another call. The exercise price of the call you sell will be below the exercise price of the long call, so this strategy will always generate a credit when it is opened.
The risk profile of this trading strategy is summarized in the diagram below.
Source: The Options Industry Council
The trade has limited up side potential and limited risk. But, this strategy will allow traders to generate potential gains in a stock they might otherwise find too risky to trade.
The maximum potential gain with this strategy is equal to the amount of premium received when the trade is opened. The maximum loss is equal to the difference between the exercise price of the options contracts less the premium received.
A Bear Call Spread in CLVS
For CLVS, we have a number of options available. Short term options allow us to trade frequently and potentially expand our account size quickly. Short term trades also reduce risk to some degree since there is less time for a news event to surprise traders.
In this case, we could sell an May 18 $60 call for about $2.50 and buy an May 18 $65 call for about $1.00. This trade generates a credit of $1.50, which is the difference in the amount of premium for the call that is sold and the call.
Since each contract covers 100 shares, opening this position results in immediate income of $150. The credit received when the trade is opened, $1.50 in this case, is also the maximum potential profit on the trade.
The maximum risk on the trade is about $350. The risk is found by subtracting the difference in the strike prices ($500 or $5.00 times 100 since each contract covers 100 shares) and then subtracting the premium received ($150).
This trade offers a potential return of about 42% of the amount risked for a holding period that is about five weeks. This is a significant return on the amount of money at risk. This trade delivers the maximum gain if CLVS is below $60 when the options expire, a likely event given the stock’s trend.
Call spreads can be used to generate high returns on small amounts of capital several times a year, offering larger percentage gains for small investors willing to accept the risks of this strategy. Those risks, in dollar terms, are relatively small, about $350 for this trade in CLVS.
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