Macro Tsimmis

intelligently hedged investment

BUY Dendreon (DNDN) puts and calls—straddle play (again)

Posted by intelledgement on Thu, 29 Jan 09

Yep, we implemented this same trade two years ago prior to the FDA advisory committee meeting that endorsed Provenge, pushing DNDN stock from $4 to $25…a month before it was—shockingly—not approved by the FDA itself, crashing the stock back down to $5—and it was our best speculative play so far, with a 307% ROI in 21 days. The time horizon here is a bit longer, but the principle is the same: there is a binary event approaching on a predictable time frame that is highly likely to materially effect the stock price of Dendreon (DNDN), the biotech developer of Provenge, a vaccine for prostate cancer.

OK, first we suggest you check out this Minionville article which summarizes what is at stake for Dendreon and their prostate cancer product, Provenge and frames the eventualities. Essentially, if the data from the IMPACT Phase III study meet the 22% threshold (with respect to improved survival for the Provenge arm as compared with the placebo arm), then FDA approval is all-but assured and DNDN stock, currently around $3.50, is likely to double or triple at least on the expectation that Dendreon will get revenues starting this year and be profitable by 2011 or even late 2010.

If the data don’t pass muster, the company will probably have to put themselves up for sale, as they lack the funds for another costly Phase III trial—to say nothing of another two-to-three years of paying the electric bill—and are not likely to be able to raise them for what would at that point be a two-time loser vaccine. (They have other candidate drugs in their pipeline, but they are all “active cellular immunotherapies” based on the same process as Provenge, so if Provenge doesn’t work….) Whether any other company would be willing to pay anything for the privilege of sinking more money into funding another study of a two-time loser drug is unknowable, but at that point, DNDN shareholders would be begging, not choosing…and in this event, the stock is likely to plunge 80% or more.

So, we are going with an options straddle play: looking to buy eight Aug $5 calls (UKOHA) for $1.25 or better and six Aug $5 puts (UKOTA) for $3.35 or better. There is healthy open interest for both options. Remember that option prices are quoted in “per share” terms, but each option covers 100 shares; thus one UKOHA August $5 call will give us the right to purchase 100 shares of DNDN for $5/share between whenever we buy it and the day the option expires (21 Aug 09 in this case). Thus the total investment (not counting transaction costs) should be around $1,000 for the eight calls plus $2,010 for the six puts for a total of $3,010.

If the data fail to meet the 22% survivability advantage for Provenge and the stock tanks the expected 80% to 70 cents or so, then the calls will expire worthless but the puts will be worth $430 each for a total of $2,580, or a net loss of (coincidentally) $430. If the stock goes down below ten cents, we will just about break even.

If the data are good and the stock goes up to $14—we don’t think $25 is likely this time until there is actual FDA approval, investors having been burned once—then the puts expire worthless and the calls will be worth $900 each for a total of $7,200, or a net profit of $4,190. If the stock reachs $18, then the calls are worth $1,300 each for a total of $10,400 (net profit of $7,390).

Of course, the risk is that there will be some sort of grey result that only modestly boosts or hurts the stock. For example, there might be a delay in the release of the data, or the results might be fractionally below 22% such that the company elects to apply for approval again anyway based on these results, thus delaying a resolution. Worst case is the stock going up from the current $3.50 to $5, in which case both the puts and calls expire worthless.

Our bet, however, is that even if delayed, the data will be available by mid-August and that any result other than an unequivocal 22% survival edge for the Provenge arm will tank the stock. (And, of course, good results will send it soaring.)

This is a relatively unusual situation where the timing of an event that is likely to have a huge effect on the stock price is known about beforehand: you don’t get better straddle opportunities than this. The way we see it, we are buying a 50%(?) chance to make four-to-seven thousand dollars at a probable risk of $400…pretty attractive odds.

Previous DNDN-related posts:


One Response to “BUY Dendreon (DNDN) puts and calls—straddle play (again)”

  1. We got our six puts early yesterday at the better-than-budged price of $3.29…but the calls stubbornly remained too pricey for our $1.25 bid all day, so rather than end up with an unbalanced position, in the afternoon we ended up buying seven calls at $1.50 instead of the planned eight calls at $1.25.

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