The Holy Grail
I’ve never been a patient person. I don’t care much for an investing strategy of gaining an average of 8% a year to build a comfortable retirement account. That would make sense, and sense is for everyone else. What I’m trying to figure out is if I can be smarter than the vast majority of traders: smart enough to increase my stake by 50%, 100%, or more a year and accumulate enough wealth to change my life in unpredictable ways. That’s one reason why I’ve chosen the most volatile of sectors as my domain. On any given day, one or two of the biggest gainers and biggest losers are likely to be small cap biotechs and pharmas. Unfortunately, the majority of these stocks will end up as losers so when you’re betting long the odds are stacked against you. There won’t be any more biotech bubbles for the foreseeable future – the year 2000 took care of that.
I’m coming to the belief that the S&P is going to be whipsawed for years, and any long who likes to watch his investments is going to be stewing in a sea of frustration. No matter how good you are, your picks are going to get dragged under every wave of pessimism. So should we bear the slings and arrows of economic misfortune, or take up arms against the erosion of our brokerage accounts?
Red thumbs in CAPS have helped me to understand the Holy Grail of the trader in a sideways market, a brokerage account that grows independently of the direction of the S&P. Every individual bet must still be affected by macro factors, but on average the strategy wins regardless of the prevailing sentiment. Of course, in order to accomplish this the trader must bet in both directions.
I’m psychologically opposed to shorting stocks. I have a hard time taking losses on my bets, and not having the resolve to exit a short with a loss is extremely dangerous. One bad bet can wipe you out. For me, the clear choice is puts. Obviously, an option that expires worthless is a lost bet, but the loss is limited to the cost of the option. And with the extreme volatility of baby biotech, puts can have a high probability of success if you find a company whose pure crappiness has been overlooked (it’s not that hard).
I’m going to maintain my GBMB strategy for long bets. It’s done well enough for me this year but it’s not going to make me rich. Clearly, the strategy needs to be complemented by some well-chosen puts to take advantage of the next leg down (yes, it’s inevitable). Here are the companies I’m watching closely for opportunities:
Orexigen (OREX) – the share price should have been decimated by the negative FDA advisory panel verdict for Arena. Instead, it’s gone up. I think the likelihood of a positive panel vote for Contrave in December after negative votes on Qnexa and Lorqess is about 10%. I’d look to get into January puts if they seem well-priced with a share price back over 7.
Savient (SVNT) – I thought Krystexxa’s approval was priced in at 15 and didn’t pay too much attention to the PDUFA this week. Ouchie when I saw the stock shoot up 35% on approval, opportunity lost. I guess some people didn’t think the 14-1 advisory panel vote was a virtually guaranteed approval. But the current share price over 20 seems to be froth over the company’s avowed pursual of a buyout. Will Krystexxa annual revenues approach the 500M or so necessary to justify a buyout at that price? My instinct tells me no. I’d look at a fairly long-term put on Savient if the share price floats up over 24.
MELA Sciences (MELA) – my red thumb on this stock is going to be coming soon, and will lay out my position for a painful and definitive rejection of the MelaFind device by the FDA advisory panel in November. The panel was already delayed once and some options players got killed, so I’d wait until shortly before the panel meeting to buy December puts. Another price run-up over 8 would be nice as well.
Pharmacyclics (PCYC) – the biggest mystery in baby biotech is the pricing of this perma-disappointer. A 430M market cap for two weakly effective lymphoma drugs in early phase trials? Sounds like Trubion with a market cap of 60M (before the 90M buyout). Even heavy dilution hasn’t put a dent in Pharmacyclics’ rise this year. Eventually sanity will prevail. Consider in-the-money puts with at least a six month horizon.
Clinical Data (CLDA) – another completely disproportionate market cap here. I’ve laid out my feelings about Clinical Diagnostics in my underperform pitch here. The financials are horrendous and I honestly don’t see how this company hasn’t gone bankrupt. There’s a PDUFA for an anti-depressant viladozone on 1/22/11 which I don’t expect to make much of a commercial splash even if it gets approved first-pass. The upcoming PDUFA might bolster the share price so I’m hoping for an approval to blast it over 20. A deep in-the-money put should take maximal advantage of the sell-after-the-news reaction and continuing losses.
NPS Pharmaceuticals (NPSP) – NPS has a ton of debt and uses most of their royalty revenues to make interest payments. It’s not clear how much longer that revenue stream will last, and lately the company has started to go down the dilutive financing route. The company’s future seems to depend on results of the phase III STEPS trial of Gattex for malabsorption in short-gut syndrome. Considering that the last phase III trial of Gattex ended with less than stellar results, I wouldn’t base a market cap of 372M on the prospects for STEPS. Nevertheless, that’s what the market is doing. With a shareholders equity approaching negative 200M, NPS has a long way to fall with a STEPS failure. I might see if this one goes above 7 later in the year before buying puts with a six month horizon.
Cell Therapeutics (CTIC) – this company is going to go bankrupt. They’ve just received shareholder approval to raise cash by issuing 400M new shares to raise the total to 1.2B. Yes, you read that correctly. Their only pipeline asset (to use the term loosely) is pixantrone, which was on the wrong side of a 9-0 FDA Advisory Panel vote in March of this year and a subsequent FDA rejection in April. Their only hope is an appeal to the FDA. Good luck with that. Despite the stock’s low low price, there’s still a busy options market. The question of bankruptcy is not if but when, and a large bet with a long horizon could be very profitable. I would look for some false positive catalyst to whip the price north towards 1 and then jump. Management is easily unscrupulous enough to make this happen.
I’ll flesh these out once I make a decision to buy the option contracts. I’m planning to make about $2000 bets until I’m sure that I can profit on average and that the strategy complements my GBMB approach, and then increase to $5000. If the market continues to float upward, new put candidates should be appearing on a regular basis. Hopefully, like Indiana Jones, I’ll choose my Grail wisely.