* Vertex Pharma (VRTX) - Biotech Erupts on Data; Option Market Understated Risk. How We Could Have Seen that a Month Ago.

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VRTX is trading $93.58, up 40.5% with IV30™ down 67.8%. The Symbol Summary is included below.

Provided by Livevol

UPDATE: 6-25-2014

Provided by Livevol

Note the stock is moving, even after the news.

This is a follow up to an article I published on Sunday, May 11, 2014:
VRTX - Huge Enterprise Changing Event Brings Decade+ Risk in Biotech & Unknown Timing.




Conclusion
As the title implies, we knew huge news was coming, we didn't know when and we didn't know how big the move would be. The option market implied a price range of [$46, $84] by the end of trading on Jun 27th or any day before.  The option market was wrong... again.

Here's how we can see that pricing; check out the option montage as of May 21st, below:

Provided by Livevol


Provided by Livevol

With the stock trading at $65.05, the Jun 27th $65 straddle priced in a range of [$46, $84] (take the strike price of $65 and add the price of the calls and puts (the straddle) = ~$19.

Range = [Strike - straddle, Strike + straddle]

Option Market: "Oops..."

News:
---
Vertex Pharmaceuticals shares soared on Tuesday after the biotechnology company said results from a late-stage trial of its cystic fibrosis treatment met its primary goals.

Lumacaftor, the pill at the centre of the trial, was used in combination with another tablet Vertex has already brought to market and is meant to treat the most common form of cystic fibrosis.

Source: Financial Times via Yahoo! FinanceVertex soars on cystic fibrosis results
---

Let's turn to the all-time stock chart, below.

Provided by Charles Schwab optionsXpress

Two obvious and noteworthy phenomena to look at:
1. The huge stock move up today.  This was truly an "enterprise changing event."  VRTX is up more than 40%.

2. Even with this move, note that the stock is still below the all-time high hit in the most ridiculous bubble of our lifetimes: not the Internet bubble, the biotech bubble at the end of the Internet bubble in 2000.

But now that the event is out, we have some point in time (real-time) analysis to do.

Let's turn to the IV30™ chart in isolation, below.

Provided by Livevol

The implied volatility is the forward looking risk in the equity price as reflected by the option market (IV30™ looks forward exactly 30 calendar days). We can see the enormous run up in risk which was the signal to anyone, whether the read news or not, that a gigantic event was coming out.  This is the unabashed beauty of options and volatility.

The risk has now collapsed (as it should) with the news out.  The question becomes, is the risk priced correctly now?  We can form a clear tangible decision by looking at the  Options Tab.

Provided by Livevol

Using the at-the-money (ATM) straddle for the June 27th weekly options we can see that the option market reflects a price range of [$89, $99] (ish).

Doing the same thing for the July monthly options we can see that the option market reflects a price range of [$86, $104] (ish).

• If you believe the stock will be outside that range on expiry or any date before then, then you think the volatility is too low.
• If you believe that range is too wide, and that the stock will definitively be in that range on expiration, then you think volatility is too high.
• If you're not sure, and can make an argument for either case, then you think volatility is priced just about right.

This is trade analysis, not a recommendation.

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