ALKS - Options Order Flow into FDA Decision

Discussion in 'Options' started by livevol_ophir, Mar 12, 2010.

  1. livevol_ophir

    livevol_ophir ET Sponsor

    Details, trades, charts, skew,prices here:

    ALKS closed at 12.64 yesterday.

    The company is in a three way partnership with AMLN and LLY for a drug and possible new applications for it. The FDA PDUFA meeting is scheduled for 3-12-2010 (today).

    ALKS traded 25,000+ options yesterday on total daily average volume of 2,306. The largest trades were the sale of the Apr 10 puts, purchases of Apr 12.5 calls and sale of the Apr 15 calls in a three way spread paying net $0.40. The Stats Tab and Day's biggest trades snap are included (in the article).

    The Options Tab snap illustrates the trades - the sizes on all three lines are greater than the OI - this is an opening position. Note also the front month vol nearly 70 points above Apr and 90 points above May.

    A multi-leg strategy is often times easier to understand by breaking the trade down:
    Sell Apr 10 puts @ $0.45
    Buy Apr 12.5/15 call spread for $0.85 ($1.30 and $0.45)

    So this is the purchases of a call spread (bullish) funded by the sale of puts (bullish) ~3,500x. Max gain is ($2.5 - $0.40)x 3500 x 100 = $735,000 on an outlay of 3500 x 100 x $0.40 = $140,000 or approximately a 5:1 max payout. Max gain is achieved at $15 (or above). Max loss is at stock going to $0 (i.e. short puts).

    The Skew Tab snapshot is included (in the article). Notice the extreme vol in the front month (red) relative to the other months (and specifically the second month - yellow). This is expected as the vol event is - right now. Note also the shape of the front month - it's more parabolic than a smirk - the options are essentially indicating no directional bias if not slightly upward.

    Skew Legend:
    Red - Front month
    Yellow - Second month
    Green - Third month
    Blue - Fourth month

    Finally, the Charts Tab (1 year) is in the article. The stock price is the top portion, the vol chart is the bottom. The red line in the vol section (IV30™) is well above the blue line (HV20™) but this expected with an FDA decision due.

    Ultimately there was bullish sentiment for the decision due today. This is trade analysis, not a recommendation.

    Details, trades, charts, skew,prices here:
  2. livevol,

    Interesting information there. I had a few things I was curious about just to see if I'm understanding this correctly. You mention the outlay of cash was about $140K ($45 * ~3500 qty), but the max loss would be much higher, right - possibly $3.5 million if it went to 0 (which I'm assuming isn't considered likely even if the FDA denied approval).

    So, while the payback ratio looks good if the stock is over $15.00, there certainly is quite a bit of risk and the losses would add up if the stock fell below $10.

    I am curious as to why someone would sell the 15 calls in this situation? Regardless of IV or even resistance of a stock or anything like that, FDA Approvals can shoot a stock up, such as recently happened with ITMN - why risk loosing so much money in theory on a real bad downside move, but limit your upside so much? If ALKS even hit $20, the 15 strike calls would have cost this position a huge amount of money, not to mention if it went to $25 or higher.

    It's different then if there was insider info and someone know a company was going to be bought out for say $39, the insider might by the 35 calls and sell the 40s because they aren't going to be hit anyway, but even if someone knew about FDA approval coming, they wouldn't be certain how high the stock might go.

    I guess it just seems like if someone felt confident that FDA approval would happen, they wouldn't cap their gains so much here, when the downside is still threoretically unlimited. I guess the idea might be they expect FDA approval, but expect the stock to only move up modestly (13-14-15 range)?

    What are your thoughts?


  3. livevol_ophir

    livevol_ophir ET Sponsor

    Everything you said is correct. The max loss is much greater than the cost of the spread for sure. The selling of the calls implies the bullish bet isn't a huge move up. Also, selling the wings of FDA announcement companies is sort of the "standard" convention. Sell the wings buy the meat (which happens to be the exact opposite of a normal stock). The naked sale of the puts implies a fairly comfortable bet that the stock will not fall apart... we'll see...