A Medical Advance May Not Reverse This Downtrend
Trading biotech stocks can be a challenge since there are times when what seems to be good news for the company fails to boost the stock. One example includes, as Biz Journals reported,
“A potential one-shot-and-you’re-done hemophilia A treatment from BioMarin Pharmaceutical Inc. will target regulatory approval in the United States and Europe after showing dramatic decreases in bleeding during clinical trials.
But in a competitive market to find the next big and expensive treatment to help — or even cure — hemophilia A patients, questions linger around how long the treatment sticks with patients. BioMarin (NASDAQ: BMRN) apparently didn’t allay those concerns [recently]:
The company said its treatment appeared to plateau in restoring the amount of a clotting protein, known as Factor VIII.
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The so-called durability of BioMarin’s valoctocogene roxaparvovec — or “valrox,” for short — could have an impact on the treatment’s ultimate acceptance by patients and what the company can charge for it.
[Also, recently], Novartis AG said it would charge $2.1 million for a gene therapy to treat a muscle-wasting disease known as spinal muscular atrophy.
BioMarin stock fell on the news.
On the surface, BioMarin’s disclosures around valrox Tuesday are positive. The company said a late-stage clinical trial found that eight patients met pre-specified criteria for Factor VIII activity levels.
That study and a Phase I/II study dropped the median number of annual bleeding events to zero after three years, and the company thinks valrox could hit the market by the end of 2020.
The drop in the number of bleeding events is significant, both from a statistical point of view and for patients. Hemophilia A, also known as “classic hemophilia,” is a genetic disorder that causes the body to produce little or no Factor VIII.
Without the clotting protein, minor cuts can turn into life-threatening bleeds and bruising can cause blood to pool around and damage joints and muscles.
There are about 20,000 people in the United States with hemophilia A, according to the National Hemophilia Foundation, and some patients in the earlier-stage study had a median of 16.3 bleeding events in the year before entering the study; valrox brought that to virtually zero.
Traders have been selling the stock and BMRN has been in a down trend for some time. For now, the path of least resistance in the stock price appears to be down.
A Trading Strategy To Benefit From Weakness
A price decline often results in higher than average options premiums. That means option buyers will be forced to pay higher than average prices for trades, But, sellers could benefit from the higher premiums.
In this case, with a bearish outlook for the short term, a call option should be sold. The call should decline in value if the stock declines and sellers of calls benefit from this decline.
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 traders can consider is the bear call spread. This is a trade that 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. The call is sold to limit the risk of the trade. So, this strategy will always generate a credit when it is opened and will always have limited risk.
The risk profile of this trading strategy is summarized in the diagram below which shows the limited risk and reward.
Source: The Options Industry Council
While risks and rewards are limited, this strategy will allow traders to generate potential gains in a stock they might otherwise find too risky to trade. Many individuals ignore bearish strategies because of the risks.
You’ll know the maximum potential gain with this strategy as soon as it’s opened. It 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 and is also known.
Every day, we scan the markets looking for trades that carry low risk and high potential rewards. These trades are available almost every day and we share them with you as we find them. Now, it’s important to remember these are trading opportunities in volatile stocks.
When we find a potential opportunity, we evaluate it with real market data. But because the trades are volatile, the opportunities may differ by the time you read this. To help you evaluate the current opportunity, we show our math and explain the strategy.
A Bear Call Spread in BMRN
For BMRN, we could sell a July 19 $85 call for about $3.90 and buy a July 19 $90 call for about $2.15. This trade generates a credit of $1.75, which is the difference in the amount of premium for the call that is sold and the call.
Remember that each contract covers 100 shares, opening this position results in immediate income of $174. The credit received when the trade is opened, $175 in this case, is also the maximum potential profit on the trade.
The maximum risk on the trade is about $325. The risk can be 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 ($175).
This trade offers a potential return of about 53% of the amount risked for a holding period that is relatively brief. This is a significant return on the amount of money at risk. This trade delivers the maximum gain if BMRN is below $85 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 $325 for this trade in BMRN.