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Test Data Creates a Biotech Opportunity With Potential Income of More Than 60%

Test Data Creates a Biotech Opportunity With Potential Income of More Than 60%

Incyte (Nasdaq: INCY) was cut to neutral from buy at Mizuho Securities USA following the failure of a promising drug from the biotech company. The stock dropped on the news.

INCY daily chart

Incyte Corporation is a biopharmaceutical company focused on the discovery, development and commercialization of therapeutics. Its portfolio includes compounds in various stages, ranging from preclinical to late-stage development, and commercialized products, such as JAKAFI (ruxolitinib) and ICLUSIG (ponatinib).

JAKAFI (ruxolitinib) is indicated for the treatment of patients with intermediate or high risk myelofibrosis (MF) and for the treatment of patients with polycythemia vera (PV) having had an inadequate response to or are intolerant of hydroxyurea.

As of December 31, 2016, the Food and Drug Administration had granted JAKAFI orphan drug status for MF, PV and essential thrombocythemia. The primary target for ICLUSIG is B Cell Receptor-ABL, an abnormal tyrosine kinase that is expressed in chronic myeloid leukemia and Philadelphia-chromosome positive acute lymphoblastic leukemia.

The company also has a portfolio of selective janus associated kinases 1 (JAK1) inhibitors.

The Street reported,

“Analyst Mara Goldstein also set the price target on Incyte shares to $79, implying a drop of 8.1% from the stock’s closing price Thursday of $85.97.

The average price target on Wall Street for Incyte is $92.65, according to Bloomberg.

Incyte’s GRAVITAS-301 study evaluated itacitinib in combination with corticosteroids to treat acute graft vs. host disease. In GvHD, donated bone marrow or peripheral blood stem cells view the recipient’s body as foreign, and the donated cells/bone marrow attack the body, according to Cleveland Clinic.

The treatment, Incyte said, vs. placebo “was not statistically significant.”

“The result of this study is disappointing. However, we remain committed to building on the success of the REACH program for ruxolitinib, which showed positive results in steroid refractory acute GVHD.

Additionally we will continue to study the role of JAK inhibition in chronic GVHD and in the prophylactic setting, as we seek to develop treatments for patients with this debilitating and often fatal disease,” said Dr. Steven Stein, chief medical officer at Incyte.

Itacitinib “is a novel and selective JAK1 inhibitor currently in clinical studies for the first-line treatment of patients with acute and chronic GVHD,” Incyte said on its website.

Piper Jaffray analyst Tyler Van Buren said while the failure of Gravitas-301 was “surprising,” the selloff was an overreaction that creates a buying opportunity.”

However, the longer-term chart of the stock using weekly data shows that the recent selloff comes as the stock was struggling to break a down trend that has been in place for some time.

INCY weekly chart

The sell off comes as the price was struggling to break through resistance near $90, a price level that has stopped advances for nearly two years and has now held at least three times. From a technical perspective, the chart is now bearish and lower prices are more likely than higher prices.

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 INCY

For INCY, we could sell a January 17 $77.50 call for about $2.50 and buy a January 17 $80 call for about $1.54. This trade generates a credit of $0.96, 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 $96. The credit received when the trade is opened, $96 in this case, is also the maximum potential profit on the trade.

The maximum risk on the trade is about $154. The risk can be found by subtracting the difference in the strike prices ($250 or $2.50 times 100 since each contract covers 100 shares) and then subtracting the premium received ($96).

This trade in INCY offers a potential return of about 62% 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 INCY is below $77.50 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 $245 for this trade in INCY.