Wednesday, August 11, 2010

Penwest Pharma (PPCO) - Looking for the HUGE Win in a Pharma

PPCO closed unchanged at $4.96, with IV30™ dropping to 4.76. The LIVEVOL™ Pro Summary is below.

I searched long and hard for a story that wasn't about the market collapse today. I found a good one...

The company traded over 12,000 options on total daily average option volume of just 1,252. 10,000 contracts went up in a Mar '11 5 put purchase for $0.055 (on the splits). The Stats Tab and Day's biggest trades snapshots are included (click either image to enlarge).

So how the hell did an ATM put in 7 months for a small pharma trade for a nickel!? Here's the news:

Endo Pharmaceuticals has announced actions to acquire all outstanding shares of PPCO for $5 in cash per share. PPCO has been working with Endo since 1997 on the development and commercialization of Opana ER.

Under the terms of the merger agreement, Endo will shortly commence an all-cash tender offer to acquire 100% of the outstanding common stock of PPCO for $5 per Penwest share. The tender offer is expected to be completed in September 2010.

Endo will acquire any Penwest shares that are not purchased in the tender offer in a second-step merger which is expected to be completed during the fourth quarter of 2010 at the same price per share paid in the tender offer. The tender offer will be subject to certain closing conditions, including a minimum condition that not less than a majority of shares of Penwest common stock are tendered into the offer.

Tang Capital Partners, and Perceptive Advisors, shareholders of Penwest, and Jennifer Good, Penwest's president and CEO, who collectively own 38.6% of fully diluted common stock of Penwest, have committed to tender their shares in the tender offer.

So there you go. The company is going to be bought for $5 share; big shareholders are in.

But now, this has happened:
The Law Office of Vincent Wong is investigating the Board of Directors of PPCO for possible breaches of fiduciary duty and other violations of state law in connection with the sale of the Company to Endo Pharmaceuticals Holdings Inc.

The investigation concerns whether the Penwest Board of Directors breached their fiduciary duties to Penwest stockholders by failing to adequately shop the Company before entering into this transaction and whether Endo is underpaying for Penwest shares.

When I first came to the floor it took me a while to learn how the big guys traded takeover. This is an example of one simple way. When everything seems to point to a deal, buy ridiculously cheap vol for pennies and see if you can't turn $1 into $20.

The Options Tab (click to enlarge) illustrates that the puts are opening (compare OI to trade size).

The stock traded ~4 million shares today on average daily volume of 400k. It looks to me that someone bought these puts for $0.015 cents (one and a half cents) over parity and turned it into a straddle (5,000 synthetic calls and 5,000 puts). I love it!

Trade Stats
Buy 10,000 Mar '11 5 puts for $0.055
Buy 500,000 shares of PPCO stock for $4.96
Straddle = $0.55 + $0.015 = $0.07.
Max loss is $70,000 for 5,000 straddles in Mar'11 !

Scale that down by a factor of 100 and it looks more realistic for a "normal" person.
Buy 100 Mar '11 5 puts for $0.055
Buy 5,000 shares of PPCO stock for $4.96
Straddle = $0.55 + $0.015 = $0.07.
Max loss is $700 for 100 straddles in Mar'11. If the deal falls apart the stock probably goes back to ~$2.50 level or lower. A bigger bid, who knows, maybe the stock rips another couple bucks.

If the stock goes to it's 52 wk low of $2.50 (ish), the 5,000 Mar'11 5 puts are worth $1,250,000 (on a $70,000 bet). That's better than 20:1.

Exciting? Yes. But it also means the odds are worse than 1:20 that this thing hits a bump in the road. Keep in mind, even the hint of a problem send the ATM straddle WAY higher than $0.07. I love this cheap trade - expecting a 100% loss on small capital, but allowing for a huge win.

Finally, the Charts Tab (3 months) is below (click to enlarge). This is vol only (IV30™ - red vs HV20™ - blue).

You can see the vol collapse on the news.

This is trade analysis, not a recommendation.

Legal Stuff:


  1. Who sold them? Mar 11' 5 puts for 0.055? The seller must be out of his mind...

  2. I was thinking the same thing; read my mmind.

  3. What do you mean, who sold them? Someone who likes 20:1 odds and has the capital to back it up.

    That's what good brokers do, find the counterparty that's "out of their mind"!

  4. As said by one of the best of the best on the floor; Don't let him fool you - that's Darren Story of Student Options on the floor. And yes, he's a damn good broker.