Guest written bysubscriber Todd Nation:
Ahh, to be able to take a pill and magically loose those unwanted pounds. I’d be a buyer and so would 80% of Americans I’m sure… Which, is the thought going through everyone’s mind and the reason this company recently experienced a surge in volume coupled with a huge price run-up from a low of 2.70 to a high of $8 before fading to the 6.80’s (at the time of writing).
This huge run up echoes the old adage buy the rumor sell the news but in this case its buy ahead of the FDA news on Sept 16th and on the failings of rival VIVUS, Inc. (VVUS) (who recently got turned down by the FDA for approval of their weight loss drug due to health concerns).
At this point it’s a guessing game where the stock will be on Sept 15 but I’m expecting the stock price to remain inflated until the FDA knocks the company down a peg at the meeting . As with VVUS prior, I intend on playing this stock the exact same way , which proved to be quite profitable. That is to take a short position on Sept 15. But given the difficulty in finding shares and the slim but possibility the drug gets approved I will be utilizing options to take full advantage of the future downfall of the stock coupled with giving myself a much better risk reward picture then shorting alone. This can be done two ways.
I can sell the $10 Sept. Calls and buy the $11 for a net credit of .25. This is the same as shorting the stock at $10 and having a stop loss at $11 with a built in pre-determined profit of .25c. I like the odds of this play for three reasons. First, the likelihood of this drug making it through the FDA approval process unscathed is quite slim. Secondly, even if the drug gets approved it has already had a terrific run-up and to go all the way to 10 would be highly unlikely… how unlikely, well my statistical models loosely based on Nobel price winning economist Black Scholes puts the likelihood at 18.75% so the odds are squarely in your favor and when you add the .25 you took in initially your breakeven price would be $10.25 which is even more unlikely to occur at 17.97%.
Even those stats I believe are skewed because in all likely hood the stock and subsequently the options will be closed to trading on the 16th. Thus, there will potentially only be one day of trading on Sept. 17th before the options expire. It kind of makes you wonder if perhaps these drug companies time the FDA meetings to coincide with option expiration dates.
Finally, the second way to short ARNA with options (and the more profitable but somewhat riskier) would be to purchase the puts. This is essentially the same as shorting the stock at the stike price minus the price you pay for the option.
In conclusion, my target price for ARNA on Sept 17 is below 2.50. Currently, I have a small position short and plan on adding to it on Sept 15th. No matter what I feel like Ill be a big winner on this play. If the stock plummets I make money if the drug gets approved and is effective I will get skinny.
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