Volatility Offers Investors a Chance to Capture a 184% Gain
Trade summary: A bull call spread in Ultragenyx Pharmaceutical Inc. (Nasdaq: RARE) using the May 15 $50 call option which can be bought for about $3.70 and the May 15 $55 call could be sold for about $2.40. This trade would cost $1.30 to open, or $130 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 $130. The maximum gain is $370 per contract. That is a potential gain of about 184% based on the amount risked in the trade.
Now, let’s look at the details. This is a trade based on volatility. What attracted our attention to the stock was a news story. It’s important to remember that news is dominated by the coronavirus but there are other events that can drive stock prices.
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Ultragenyx Pharmaceutical Inc., a biopharmaceutical company focused on the development and commercialization of novel products for serious rare and ultra-rare diseases, [recently] announced a strategic partnership and non-exclusive license and technology access agreement with Daiichi Sankyo Company, Limited.
The agreement covers for Ultragenyx’s proprietary AAV-based gene therapy manufacturing technologies. Ultragenyx’s HeLa producer cell line (PCL) platform enables large commercial-scale AAV-based gene therapy product manufacturing that is intended to be highly reproducible, more consistent, and less expensive than other gene therapy manufacturing platforms.
In addition, Ultragenyx has developed a proprietary HEK293 transient transfection system for AAV manufacture which is also a subject of the collaboration.
Under the license and technology access agreement, Ultragenyx granted Daiichi Sankyo a non-exclusive license to intellectual property, including know-how and patent applications, with respect to its HeLa PCL and HEK293 transient transfection manufacturing technology platforms for AAV-based gene therapy products.
The parties will collaborate closely as part of a technology transfer plan to enable Daiichi Sankyo to use the technologies for its internal gene therapy programs. Ultragenyx retains the exclusive right to use its manufacturing technology for its current target indications and additional indications identified now and in the future.
“This new partnership with Daiichi Sankyo provides further validation of the value of Ultragenyx’s gene therapy-related technologies, especially our HeLa producer cell line platform that we believe is the most scalable mammalian cell AAV manufacturing system,” said Emil D. Kakkis, MD, PhD, Chief Executive Officer and President of Ultragenyx.
Under the terms of the agreements, Daiichi Sankyo will make an upfront payment of $125 million and will purchase $75 million of Ultragenyx common stock at a price of approximately $60 per share.
Daiichi Sankyo will pay an additional $25 million upon completion of the technology transfer of the HeLa PCL and HEK293 platforms as well as single-digit royalties on net sales of products manufactured in either system. Daiichi Sankyo will reimburse Ultragenyx for all costs associated with the transfer of the manufacturing technology.
This deal should provide support for the stock and that should limit downside risks with the stock moving up.
RARE traded at $90 in 2018 and has the potential to deliver strong gains to investors now that there is a viable path ahead for the company to bring its technology to the market.
A Specific Trade for RARE
For RARE, the May 15 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 May 15 $50 call option can be bought for about $3.70 and the May 15 $55 call could be sold for about $2.40. This trade would cost $1.30 to open, or $130 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 $130.
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 RARE the maximum gain is $3.70 ($55- $50= $5; 5 – $1.30 = $3.70). This represents $370 per contract since each contract covers 100 shares.
Most brokers will require minimum trading capital equal to the risk on the trade, or $130 to open this trade.
That is a potential gain of about 184% 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 RARE 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 RARE 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.