I am thinking of implementing a new trading strategy: since options are very expensive if the expiry is after the approval (since there is huge implied volatility) I am thinking of buying a stock with an upcoming FDA approval and selling an Out Of The Money call option. That way:
- If there are delays or something goes wrong during the run-up I have the premium to fall back on to cushion losses.
- If we have a nice run-up the option I sold will go up in price, but my stock will go in price more since delta is quite far from 1 in Out Of The Money options, so selling both will still deliver a profit.
- If I hold through the decision my upside is a bit limited, but again the premium cushion me in case of rejection.
An example I am trading now (09-09-2010):
Buy Avanir Pharmaceuticals (AVNR) now for $2.70 and sell a Dec. $5 call for $0.55.
- If no run-up happens comes the 30th of October or the approval is delayed you can probably re-purchase the option for much less than you sold it for (or let it expire worthless in case of delay) and still make some money that way.
- If the stock runs up to $5 the option will probably only go to $1.30 or something like that. You re-purchase your option (on which you lose $0.80) but you sell the stock @ $5.00 for a $2.30 profit, which mean that you "net" about $1.50.
- If you hold trough the decision and it is positive you maximum gain is $2.30 + the price of the option ($0.55) if you let it expire In The Money or a little bit less if you repurchase and sell the stock. This is "only" about a 100% upside!
In case the decision is negative however and the price falls to $2.00 you only lose $0.15 since the $0.55 from the premium cushion you.
Note that this example is for illustration purposes only (not trade advice).
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