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The Holy Grail



September 21, 2010 – Comments (9) | RELATED TICKERS: OREX , SVNTQ , MELA

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.       

9 Comments – Post Your Own

#1) On September 21, 2010 at 11:20 AM, Momentum21 (96.33) wrote:

Thanks for the post man...just be sure to make more than one bet!

Did you see the Hulbert Piece on Michael Murphy/Arena Pharma? Thrill seeking x 10 right there. That action is called nutting up... : )


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#2) On September 21, 2010 at 12:29 PM, portefeuille (99.56) wrote:

Savient's gout drug nod may trigger bid war


I have got bored of those "dividend paying blue chip stocks" as well and thrown them all out (see the evolution from comment #2 here to comment #70 here (okay, I kept some Volkswagen shares.)). I am still too young and too poor for those, hehe ...

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#3) On September 21, 2010 at 12:59 PM, zzlangerhans (99.73) wrote:

I appreciate the heads up on Savient, but I'm sure you didn't miss this. Pegloticase is a great drug and will change lives, but is unlikely to be widely used. How many newly FDA-approved drugs have had sales that surpassed expectations in the last few years? I'm thinking Soliris, Soliris, Soliris, can't come up with anything else. On the other side we have failures from Cypress, Progenix, Biodelivery Sciences, Neurogesix, Allos, and too many more to name. Absolutely, Savient could get bought out at 40. DO NOT SHORT THIS! And look for the price to rise counterintuitively despite silence on the buyout front over the next two months. If those conditions come to pass, then maybe risk $2000. But I do like the put prospects for the chubby drug companies better. I might be adding Vivus to the list soon ...

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#4) On September 21, 2010 at 1:26 PM, Momentum21 (96.33) wrote:

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 don't disagree with the concept of buying protection...and really like your GBMB strategy but don't you think that a "diversified basket" with cash on the side would allow you to exploit the volatility you are expecting and come out ahead?

The timeline variable of options trading seems like it might impair your returns.

The nature of what you are doing is risky (thus the reward) but I think the odds would be in your favor going long...where you risk 100% but will also get more than your share of multi-baggers.

In other words, why not simply protect your larger longs? 


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#5) On September 21, 2010 at 1:32 PM, zzlangerhans (99.73) wrote:

The problem when one buys on the dips in this market is that dips become trenches which become canyons. Then you have to decide whether to sell at a loss or add more money to the pool, which is what I've been doing. Selling the losers is an alternative strategy to shorting/puts but the problem is that a lot of my prior losers ended up winners. And sinking more and more money in will eventually just magnify your position, win or lose.

This is just an experiment, like GBMB. Might succeed, might fail. Only one way to find out ...

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#6) On September 22, 2010 at 8:20 AM, Entrepreneur58 (40.30) wrote:

Sense is for other people?  Actually, the vast majority of people love to gamble.    It appears that sense is for the minority.

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#7) On September 22, 2010 at 9:29 AM, GeneralDemon (27.72) wrote:

Go with your heart - if you shoot for the 100% returns per year I hope you make it. I have opted for the slow build - but 13% per year adds up and after thirty years goes by it's not so bad.

Maybe you could alot just a portion of your portfolio to the high risk plays? That way you could maximize your skills and lower risk.

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#8) On September 22, 2010 at 9:47 AM, CharlieBeLong (29.99) wrote:

Will you buy staggered expirations? Or, put all your money into one contract? 


Just curious what time frame you would normally need.  (I know this varies by catalyst, but curious what range of expirations you would be willing to buy).  Thx for the thoughts.

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#9) On September 22, 2010 at 11:00 PM, zzlangerhans (99.73) wrote:

#1) People do stupid things, especially in biotech. Nothing surprises me any more. And all you need to call yourself an biotech expert on the internet is a keyboard.

#7) I'm already destined to be a wealthy old man. The goal here is to become a wealthy young(ish) man. $2000 from a $400000 portfolio isn't a huge risk - I've gone down more that that on long bets the same day I made the buy.

#8) I'm heavily into simplicity. I won't be constructing any complex options chains, especially when I'm still in the baby steps mode. As you surmised, the time frame depends on whether there is an upcoming catlayst or I simply feel the stub is way overpriced. For the latter, I'm looking at mostly 6 month - 1 year expirations and in-the-money strikes. I don't underestimate the strength and endurance of baby biotech irrationality.

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