Put insurance - some ideas

[babaoriley]

Okay, I’m throwing this out for the consideration of those of you who do trade options. I've been trying to figure how to get some defensive leverage, as just buying puts is too expensive.  I will tell you, even if we get hammered by the Advisory Committee and the FDA, this strategy is not guaranteed to rescue you, but here goes.

I’ve done one basic thing, a bear put calendar spread, but done it with a couple of things in mind, so actually have entered into two distinct trades.

Trade 1: I bought May 17th, $8 strike puts, and sold an equal number of April 4th, $8 strike puts. The difference in price was about .39 (May, of course, selling for more than April), so, let’s use round numbers, so for 100 contracts of each, the net price to me was about $4,000. Here’s the general thinking: suppose that on April 1st, AdCom is moderately to very favorable, I could easily see the April 4th $8 strike puts expiring worthless or close to it (stock price gets close to or above $8). If that’s the case, I now hold 100 May 17th $8 strike put contracts (for which I'm out $4,000 plus whatever it may cost to close out the April 4th $8 puts), which places me in a position to salvage money if the FDA does us in. I purposely did not do purchase the April 19th puts (although that would have cut the net price to about .20), because I can easily see the FDA putting off the decision for a week or two, which could annihilate that strategy, but surely (or so the theory goes) they will love us or hate us by May 17th.

So, if the FDA kills us, and we go down to, say around $2, I would have a $60,000 or so profit on my 100 put contracts.

Of course, if AdCom is nasty to us on April 1, the stock will likely drop and this strategy doesn’t work all that well, because I will have to sell a bunch of my May 17th puts, in order to cover the April 4th puts on which I am obligated. I may break close to even in that scenario, or lose an acceptable amount. But we will all be devastated from the poor AdCom result, and have to rely on a Hail Mary from the FDA.

The above transaction is obviously a big loser if the FDA approves and the stock goes up above $8 and stays there – that would be okay with me!!!!!!

Trade 2 will be discussed in a separate post.

If anyone can see why the above is stupid as a defensive strategy only, please, please let me know!!!

[harshal1981]

Baba: in my opinion, AdCom is more likely to screw us than FDA this time. My thinking is that AdCom will be mixed out come. (No clear yay or nay) and that will give people even more anxiety. Not to mention, shorts will exploit the situation to their best to drive down the price sighting guaranteed FDA rejection and blah.. blah..

But in the end, my thinking is that better wisdom will prevail at FDA this time. Even with some more restrictions that we would like to see on the label, they will approve. I do believe this strategy is limiting your upside.

[harshal1981]

and by the way, if FDA kills us, and prices is down to $2, won't you have profit of $600,000 ( $8-$2 = $6 / $6*100*100= $600,000) Assuming ofcourse that you are buying 100 contracts (100*100 shares, I suppose thats how your cost of $4000 comes on the difference of 40cents).

[babaoriley]

Trade 2: I bought May 17th, $7 strike puts, and sold 5/3 as many March 28th , $7 strike puts. I needed to sell twice as many, because otherwise I’d have to come out of pocket too much. As a result, if the stock tanks on or before March 28, that strategy is toast (eg, AdCom briefing comes out around then and AF and friends have a field day with it).

Again, let’s use round numbers, so I buy 60 May 17th $7 strike puts and I sell 100 March 28th $7 strike puts, the net price to me was only about $400, so nearly negligible.

Here’s the general thinking: take a chance that the AdCom briefing that may well be released by March 28th does not cause the stock to tank, and given a little run-up to AdCom, by March 28th, hopefully the stock will be at least $7, so that the March 28th $7 puts on which I’m obligated expire worthless, or I’m able to close them out for a relatively small amount.

If that’s the case, I now hold 60 May 17th $7 strike put contracts, which, like with the $8 puts in Trade 1 puts me in a position to make money if the FDA does us in.

So, if the FDA kills us, and we end up around $2, and I would have a $30,000 or so profit on my 60 put contracts.

Again, if any of you see a fundamental (or not so fundamental) flaw in this strategy, I’d love to know.

[babaoriley]

harshal, thanks for your thoughts. 100 contracts x 100 shares is 10,000 x 6 or $60,000. For a minute there, you had me hoping my negative scenario would come true! LOL.

You may be right on the AdCom, I just hope we have a favorable AdCom and FDA both, far less angst for us all! Also, I really, really, don't want to be bombarded with the crap that's going to fly if AdCom is skeptical.

[harshal1981]

Not sure how the hell i had one zero more !!! I wish... :-).

[mrhaigs]

Baba- I'm big into options myself. I have all kinda of calls going on for mnkd. I've been weighing the same types of trades myself, but have convinced myself that we will have a runup to or around $8 at the end of march. I do believe that ther adcom is going to be the make it break. I like your strategy on trade #2. I've already sold 15 march $8 calls and 15 $8.50 calls in hoping ill have the 3,000 shares called away to make a little money. I also have a bull call spread of $6/8 strikes. This in addition to te thousands of shares and options I have on a bullish call. I may sell some of my may $10 strikes if we have a runup too.

That being said I like the may puts and not the April because if we get a FDA delay of a even a week the April puts become worthless turds(assuming the adcom is favorable). I would execute your trade #2 of wait till later in march if you believe that we will have a runup and just flat out buy the puts as they should be cheaper with a higher share price.

So many options.... Literally

Mrhaigs

[babaoriley]

Senor Haigs, yes, you certainly can figure all kinds of strategies with puts and calls, and with biotech and the big premiums, and when you then throw in that we have some dates that while not certain, are likely, you can figure a way to leverage a desired position.

I will say in my experience, I'm not confident at all that the put prices will come down as much as they should, even if the stock were to hit $8 on the even of AdCom. I believe that looking for insurance by buying puts will remain too darn expensive, right to the bitter or sweet end. Now, if we had a stock trading at $35, with a similar up/down vote coming up, then I have found you can buy a nice $20 put, and if the stock plunges to $10 (as some one trick ponies do), you can do a nice job of protecting your downside.

At the end of the day, I'll probably wish I had done only the most simple thing, that is, sell a few shares right before AdCom, but part of investing in biotech for me, is doing this option stuff, to each his own!