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A Setback In This High-Flier Could Yield Gains for Traders

A Setback In This High-Flier Could Yield Gains for Traders

Sometimes, investors say bad news is good news. There is no doubt in this case that the bad news is bad.

The Boston Business Journal reported, “Sarepta Therapeutics stock dropped … after news emerged that a child participating in a trial of the company’s experimental gene therapy for Duchenne muscular dystrophy experienced a serious health complication.

SRPT daily chart

Sarepta (Nasdaq: SRPT) has been testing a treatment for the rare disease that would insert a functioning gene into patients with the disease, who have a non-working copy of the gene.

The biotech’s stock quickly dropped [after] it was reported in an FDA database that a 7-year-old trial participant was hospitalized with a potentially life-threatening condition that can lead to kidney failure.

In a public statement, the company said that the hospitalization was “erroneously” submitted to the FDA by someone outside of the company.

The statement added that the clinical trial has been designed so that neither the subject nor the company are aware if they’re receiving the gene therapy or a placebo. The health complication the boy experienced is one commonly associated with Duchenne, the statement said.

The statement appeared to contradict CEO Doug Ingram‘s comments during an during an earnings call [the previous day], when he said the company had “no evidence of significant adverse or serious adverse events.”

Asked about Ingram’s comments, a company spokesperson said that “the study review board … reviewed the event and recommended the trial continue. No stopping rule in Study 102 was triggered.”

The spokeswoman added that the event was “reported through the appropriate clinical trial protocol.”

Sarepta’s drug, SRP-9001, was developed at Nationwide Children’s Hospital in Ohio — the same facility where the gene therapy recently launched by Novartis (NYSE: NVS) and subsidiary AveXis was created.

The FDA reported earlier this week that data from animals that had taken the drug had been

When asked … if he had concerns about the integrity of early SRP-9001 data, due to the shared origin, Ingram told analysts, “there’s nothing about that issue that reads through to anything we’re doing at all. It appears to be a very specific issue with a very specific person or couple of people at that company.”

Ingram stated [earlier] that it is pushing back the start of another test of the drug, which had originally been expected to start in the fourth quarter of this year. It’s now scheduled to begin in the first half of 2020.

This pushes SRPT out of a trading range and could indicate additional declines are likely.

SRPT weekly chart

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.

bear call spread

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 SRPT

For SRPT, we could sell an August 16 $125 call for about $4.50 and buy an August 16 $130 call for about $2.30. This trade generates a credit of $2.20, 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 $220. The credit received when the trade is opened, $220 in this case, is also the maximum potential profit on the trade.

The maximum risk on the trade is about $280. 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 ($220).

This trade offers a potential return of about 78% 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 SRPT is below $125 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 $280 for this trade in SRPT.