A Milestone in the Drug Approval Process Sets Up A Trade
In the long run, a new drug could result in moving a stock sharply higher. Over the course of years, a new drug could move a stock by several hundred percent. That’s why news about drug approval is important for investors to consider.
In the short run, the news could also create triple digits opportunities.
The Street reported on an opportunity noting, “Moderna (Nasdaq: MRNA) shares jumped… after the biotechnology company said the U.S. Food and Drug Administration granted fast-track designation for its investigational Zika vaccine.
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The Cambridge, Mass., drug developer said the vaccine, mRNA-1893, is being evaluated in a Phase I study to prevent Zika virus infection in healthy adults.
“Protecting against Zika virus transmission, particularly in women during pregnancy, continues to be an area of high unmet need,” Tal Zaks, a physician and the company’s chief medical officer, said in a statement.
“Fast Track designation supports our belief in the clinical potential of mRNA-1893 and the importance of developing an effective vaccine that can be rapidly developed and deployed. Our Zika program is part of Moderna’s broader commitment to improving global public health through developing mRNA vaccines to prevent the spread of infectious diseases.”
The Zika virus is a pandemic that has rapidly emerged in recent years and could have long-term public-health implications, the company stated. Moderna said the project has been funded in whole or in part with federal funds.
Moderna said it currently has strategic alliances for development programs with AstraZeneca and Merck, as well as some U.S. government departments.”
This news comes as the stock appears to be forming a basing pattern that could propel the stock to significant gains.
The base has been forming for several months and the breakout from a base that forms over weeks or months can be the starting point for a large price move. As the chart shows, MRNA has traded near $30 a share and the news could propel the stock back towards that level. Success ion the drug approval process could push the stock well above those all time highs.
The news is also creating a short term opportunity.
A Trade for Short Term Bulls
As with the ownership of any stock, buying MRNA 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 priced stocks where the share price and options premiums are often a significant commitment of capital for smaller investors.
A Specific Trade for MRNA
Every day, we scan the markets looking for trades with 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.
For MRNA, the October 18 options allow a trader to gain exposure to the stock.
An October 18 $17.50 call option can be bought for about $0.80 and the October 18 $20 call could be sold for about $0.30. This trade would cost $0.50 to open, or $50 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 $50.
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 MRNA the maximum gain is $2 ($20 – $17.50= $2.50; $2.50 – $0.50 = $2). This represents $200 per contract since each contract covers 100 shares.
Most brokers will require minimum trading capital equal to the risk on the trade, or $50 to open this trade.
That is a potential gain of about 300% based on the amount risked in the trade. The trade could be closed early if the maximum gain is realized before the options expire.