This New Drug Could Provide a Gain of More than 230%
Trade summary: A bull call spread in Editas Medicine, Inc. (Nasdaq: EDIT) using the September $35 call option which can be bought for about $1.95 and the September $40 call could be sold for about $0.80. This trade would cost $1.15 to open, or $115 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 $115. The maximum gain is $385 per contract. That is a potential gain of about 234% based on the amount risked in the trade.
Now, let’s look at the details.
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EDIT announced that the U.S. Food and Drug Administration (FDA) has granted Rare Pediatric Disease (RPD) designation for EDIT-301, an experimental, autologous cell medicine, being developed as a potentially best-in-class, durable medicine for sickle cell disease.
The Company plans to file an investigational new drug application (IND) for EDIT-301 by the end of 2020.
“The Editas team has a bold vision to unlock the potential of CRISPR to design and develop game-changing medicines. We are making tremendous progress towards this vision with the continued development of EDIT-301, a potentially transformative medicine for the treatment of sickle cell disease, and we are pleased to receive Rare Pediatric Disease designation from the FDA for this program,” said Cynthia Collins, Chief Executive Officer, Editas Medicine.
“We know patients are counting on us, and this designation is a significant milestone for the program that highlights the serious, life-threatening manifestations of sickle cell disease.”
EDIT-301 is an experimental, autologous cell therapy medicine under investigation for the treatment of sickle cell disease. EDIT-301 is comprised of sickle patient CD34+ cells genetically modified using a highly specific and efficient CRISPR/Cas12a (also known as Cpf1) ribonucleoprotein (RNP) to edit the HBG1/2 promoter region in the beta-globin locus.
Red blood cells derived from EDIT-301 CD34+ cells demonstrate a sustained increase in fetal hemoglobin (HbF) production, which has the potential to provide a durable treatment benefit for people living with sickle cell disease.
The stock chart shows a pattern of higher highs followed by pullbacks and brief consolidations. This pattern has been repeated every few weeks since the March bottom. The news of a new drug approval could serve as the catalyst to push the stock to a new high.
The weekly chart shows a consolidation dating back to 2017. The stock pulled back deeply after setting new highs that year. The recent price move places the stock within a few points of those highs. A breakout provides a target of $48.
A Specific Trade for EDIT
For EDIT, the September 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.
A September $35 call option can be bought for about $1.95 and the September $40 call could be sold for about $0.80. This trade would cost $1.15 to open, or $115 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 $115.
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 EDIT, the maximum gain is $385 ($40- $35= $5; 5- $1.15 = $3.85). This represents $385 per contract since each contract covers 100 shares.
Most brokers will require minimum trading capital equal to the risk on the trade, or $115 to open this trade.
That is a potential gain of about 234% 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 EDIT 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 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.