Positive Test Results Could Provide a Short-Term Gain of 85%
Trade summary: A bull call spread in Arrowhead Pharmaceuticals, Inc. (Nasdaq: ARWR) using the October $50 call option which can be bought for about $4.20 and the October $55 call could be sold for about $1.50. This trade would cost $2.70 to open, or $270 since each contract covers 100 shares of stock.
In this trade, the maximum loss would be equal to the amount spent to open the trade, or $270. The maximum gain is $230 per contract. That is a potential gain of about 85% based on the amount risked in the trade.
Now, let’s look at the details.
ARWR develops medicines that treat intractable diseases by silencing the genes that cause them. Using a portfolio of ribonucleic acid (RNA) chemistries and modes of delivery, the company’s therapies trigger the RNA interference mechanism to induce knockdown of target genes.
The company is focused on developing drugs for diseases with a genetic basis, characterized by the overproduction of one or more proteins. Its preclinical pipeline of RNA interference (RNAi) therapeutics includes both subcutaneously administered liver-targeted candidates and extra-hepatic candidates.
One of the company’s pre-clinical-stage drug candidates is ARO-AAT, the company’s second generation investigational RNA interference (RNAi) therapeutic being developed as a treatment for the rare genetic liver disease associated with alpha-1 antitrypsin deficiency (AATD).
Recently, the company released test results on Business Wire, Arrowhead ”announced positive interim 24-week liver biopsy results in four subjects from AROAAT2002, an open-label Phase 2 clinical study of ARO-AAT.”
The stock was up on the news.
The results show clear evidence of a meaningful pharmacodynamic effect by ARO-AAT, leading to improvements in relevant biomarkers, including substantial reductions in intra-hepatic mutant AAT protein (Z-AAT), both Z-AAT monomer and Z-AAT polymer; improvements in liver stiffness based on FibroScan; and, a decrease in alanine aminotransferase (ALT) and gamma-glutamyl transferase (GGT), both serum biomarkers of liver injury.”
Specific results included:
– Up to 97% reduction in intra-hepatic Z-AAT polymer
– Up to 95% reduction in intra-hepatic total Z-AAT burden
– Up to 66% and 58% reduction in circulating ALT and GGT levels respectively
– Up to 26% improvement in FibroScan values
Javier San Martin, M.D., chief medical officer at Arrowhead, said: “While we had anticipated that 6 months of treatment with investigational ARO-AAT in the Phase 2 open label study would likely lead to substantial reductions in Z-AAT monomer, the improvements in additional clinically meaningful biomarkers, including reductions in Z-AAT polymer, improvements in FibroScan values, and decreases in ALT and GGT, were more substantial than we expected.
These are very exciting results and provide us with increased confidence in the potential of this program. Based on these important data, we are actively assessing our clinical and regulatory path forward, including engaging with the U.S. Food and Drug Administration and other regulatory agencies, to identify areas where the program could potentially be streamlined and accelerated.”
Arrowhead submitted a late-breaker abstract on the interim 24-week results for the first cohort of AROAAT2002 in which 4 patients received 200 mg ARO-AAT at Week 1, 4 and 16, and, if accepted, intends to present additional data at the American Association for the Study of Liver Disease (AASLD) Liver Meeting in November 2020.
The weekly chart shows the stock was at support, a pattern that should limit risk on a trade.
A Specific Trade for ARWR
For ARWR, the October options allow a trader to gain exposure to the stock. This trade will be open for about six weeks and allows for traders to turn over capital quickly, potentially compounding gains several times a year.
An October $50 call option can be bought for about $4.20 and the October $55 call could be sold for about $1.50. This trade would cost $2.70 to open, or $270 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 $270.
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 ARWR, the maximum gain is $230 ($55- $50= $5; 5- $2.70 = $2.30). This represents $230 per contract since each contract covers 100 shares.
Most brokers will require minimum trading capital equal to the risk on the trade, or $270 to open this trade.
That is a potential gain of about 85% based on the amount risked in the trade. The trade could be closed early if the maximum gain is realized before the options expire.
A Trade for Short Term Bulls
As with the ownership of any stock, buying ARWR 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 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 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.