Biotechs Can Be Predictable At Times
Biotechnology companies can be among the biggest winners and biggest losers on any given day. The fact that they trade almost independently of their broad sector at times makes them unique in the market. Most stocks have a high correlation with their sectors.
What’s unique about biotech companies is their dependence on single drug approvals. A company usually targets one or two key processes and moves towards approval of their drug or technology. The approval process is strictly defined by the Food and Drug Administration in the US.
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Other agencies outside the US have similarly well defined processes in place. The companies must meet predefined milestones in order to advance to the next milestone. Success or failure at any stage in the process often leads to a sharp change in the stock price.
These milestones are independently set for each company and that is why the individual stocks often make large moves that are uncorrelated with their sector.
CRISPR Stumbles in the Process
CRISPR Therapeutics (Nasdaq: CRSP) is a leading gene editing company focused on developing transformative gene-based medicines for serious diseases using its proprietary CRISPR/Cas9 platform.
CRISPR/Cas9 is a revolutionary gene editing technology that allows for precise, directed changes to genomic DNA. The company has established a portfolio of therapeutic programs across a broad range of disease areas including hemoglobinopathies, oncology and rare diseases.
To accelerate and expand its efforts, CRISPR Therapeutics has established strategic collaborations with leading companies including Bayer AG and Vertex Pharmaceuticals.
Recently, shares of CRISPR Therapeutics fell sharply after the company disclosed that the FDA has placed a clinical hold on its drug application for a sickle cell disease stem cell therapy. The suspension will be in effect until CRISPR and its partner, Vertex Pharmaceuticals, answer FDA questions about the drug application.
Specifically, the FDA paused the Investigational New Drug Application (IND) for CTX001 for the treatment of sickle cell disease pending the resolution of certain questions that will be provided by the FDA as part of its review of the IND.
The IND was submitted to the FDA in April to support the planned initiation of a Phase 1/2 trial in the U.S. in adult patients with sickle cell disease. CRISPR and Vertex expect to obtain additional information on the FDA’s questions in the near future and plan to work rapidly with the FDA toward a resolution.
CTX001 is an investigational, gene-edited autologous hematopoietic stem cell therapy for patients suffering from β-thalassemia and sickle cell disease (SCD) in which a patient’s hematopoietic stem cells are engineered to produce high levels of fetal hemoglobin (HbF; hemoglobin F) in red blood cells.
HbF is a form of the oxygen carrying hemoglobin that is naturally present at birth, and is then replaced by the adult form of hemoglobin. The elevation of HbF by CTX001 has the potential to alleviate transfusion-requirements for β-thalassemia patients and painful and debilitating sickle crises for sickle cell patients.
The planned initiation of a Phase 1/2 trial of CTX001 in Europe in adult patients with transfusion dependent β-thalassemia is unchanged, and the companies expect to initiate the trial in the second half of 2018.
CTX001 is being developed under a co-development and co-commercialization agreement between CRISPR Therapeutics and Vertex.
CRISPR and Vertex entered into a strategic research collaboration in 2030 aimed at the discovery and development of gene editing treatments using the CRISPR/Cas9 technology to correct defects in specific gene targets known to cause or contribute to particular diseases.
Vertex has exclusive CRSPhts to license up to six new CRISPR/Cas9-based treatments that emerge from the collaboration, and CTX001 represents the first treatment to emerge from the joint research program.
For CTX001, CRISPR and Vertex will equally share all research and development costs and profits worldwide. This arrangement helps CRSPR advance the technology while reducing the costs.
The long term chart indicates CRSP is unlikely to bounce back soon.
Long term investors have solid gains. New investors have little reason to enter the trade in the short term because news is unlikely to arrive on that trial for at least several weeks.
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 CRSP
For CRSP, 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 a June 30 $70 call for about $0.80 and buy a June 30 $75 call for about $0.30. This trade generates a credit of $0.50, 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 $50. The credit received when the trade is opened, $50 in this case, is also the maximum potential profit on the trade.
The maximum risk on the trade is about $450. 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 ($50).
This trade offers a potential return of about 11.6% of the amount risked for a holding period that is less than one week. This is a significant return on the amount of money at risk. This trade delivers the maximum gain if CRSP is below $70 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 $430 for this trade in CRSP.
These are the type of strategies that are explained and used in our TradingTips.com’s Options Insider service. To learn more about how options can be used to meet your income and wealth building goals, click here for details on Options Insider.