Tuesday, April 27, 2010

DNDN - The Full Story Option & Market Implications

DNDN is trading 40.81 with IV30™ up 4 points to 143. The LIVEVOL™ Pro Summary is below.

I normally finish with the chart - but it's a better place to start for this company.
The Charts Tab is below (click to enlarge). The top portion is the stock price, the bottom is the vol (IV30™ - red vs HV20™ - blue). The yellow shaded area at the very bottom is the IV30™ vs. the HV20™ vol difference.

Note how the stock has gone straight up as IV30™ has also risen. This is opposite to the "normal" pattern which says vol goes down as stocks rise. Of course, the normal situation is not a bio-tech.

What's Going On?
An FDA decision is due out on Provenge - their prostate cancer drug. Start with the fantastical stock chart for the last 3 years below (click to enlarge).

This is a rough road map of events - if you're looking for absolutes, check out the news please...

The first rip up occurred when an FDA committee agreed with the results of the then tiny bio-tech that their drug did three things:
1) Extended life
2) Was safer (much safer) than chemotherapy
3) Reduced tumor sizes

Then the stock drops size: A litte after that the FDA rejected approval but said they agree with 1 and 2 emphatically - but since the endpoint (goal) of the paper DNDN published was focused around tumor size shrinkage - they could not approve it b/c they weren't convinced of this one piece.

Then the stock ripped back up - DNDN did even more research that was even more convincing of the drugs efficacy in 1 and 2 and that it also shrunk the tumors. The FDA committee agreed again. I'm not sure if DNDN has taken out the tumor shrinking claim to gain approval or if their newer data was just overwhelmingly evident of this phenomenon - either way - the drug looks like it will get approved with or without the final point.

With it looking to everyone that the drug would be approved, DNDN did some major share offerings to finance a build out of labs and manufacturing capability claiming the demand would be overwhelming relative to their capacity - so the stock kind of bumbled around.

Since then DNDN has continued to publish data in support of the drug pushing the stock higher - sort of evidence that all this build out is going to be necessary since the drug really works.

And now... The FDA is supposed to decide/rule on the drug within the next week.

What Does the Option Market Think?
Let's look at the skew chart (click to enlarge)

Normally with a bio-tech on the hook for an FDA decision the skew is parabolic - sort of even bets that it goes up a lot or down a lot. The wings are generally very expensive as the possibility for huge moves are priced in. To read in general why option skew exists CLICK HERE.

However, for DNDN, you can see what almost looks like a "normal" skew. The upside potential is muted (upside is cheap relative to downside - relative I said - it's far from cheap). The downside is extraordinarily expensive. Let's take a look at the Options Tab (click to enlarge).

Just one example are the May 25 puts - IV is 222 - they have fair value ~$2. Those break even with the stock at $23 or an $18 move down.

What Does This Imply?
The skew demonstrates that the risk now for DNDN is to the down side. Why? - Possibly b/c the approval is priced in at this point as the stock has wandered up to $42 from $25. Whatever the case, vol will implode after the decision as long as it's definitive. Even if it's not definitive, May will definitely crash.

If you think the drug will be approved and move a little, or you think the drug will not get approved - selling the upside calls could be a play. The May 50 calls are worth ~ $2. But, the May 75 calls are $0.20 bid - yikes! If the stock goes there - selling the 50's is trading suicide.

The super OTM calls are bid in case the stock rips on the news or, and also possible, the stock announces a takeover...

On the downside there a bunch of put spreads that look pretty juicy depending on where you think the stock will go.

The general (and often wrong) rule for bio-techs is to sell the wings and buy the meat. Whatever you do, being naked options is a HUGE risk. Spreads, spreads, spreads...

What spread to do?
You can sell the strike where you think the stock is going to land, and buy the strikes where the you think the stock is going away from.

This is trade analysis, not a recommendation.

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