Trading biotech / pharma events using options

[biotechpr@yahoo.com 0]

Hello,

This a high level question just to understand whether anyone in this community has experience (or at least interest) in trading options around biotech / pharma events. As a fundamental equity analyst specialising in healthcare I know everything there is to know about about drug development (that is from an outsider perspective who covered pharma / biotech for 10+ years). I don't have practical experience in using options (it's a pain to go past compliance), but have decent theoretical understanding after years of interest in options. I have never had time to actually come up with a strategy and implement it, but have more time now and a few ideas I would like to explore how this could work. 

SO strategies would not work for me, unfortunately (I am a former subscriber). I like to have a good understanding about the underlying, upcoming catalysts, etc. Also, I think trading around biopharma events would go beyond directionless strategies (which is SO's comfort zone I believe), as both the underlying and IV can make huge moves. This is where fundamental knowledge comes into play in order to time the events. At least that's my thinking.

After searching this forum (public one, don't have access to paywalled one), I only found one topic from 2013, but fairly short one. 

So again, this is a fairly high level question whether there are people here who would like to explore this topic?

Thanks 

 

[TrustyJules 3,212]

Funny you should ask this question today, I was just revisiting some work I did at two intervals on bio-tech events. I used biopharmcatalyst.com to follow the biotech events. A strategy is to find biotech events that have a very binary outcome. These tend to cause IV rises in the run up to them in the same manner as earnings do with stocks. Such predictable unknows then allow you to make several strategies that profit from the rise in IV, either by having a position that plays both sides of the outcome and profits simply because the IV makes the options (rather than the stock) more expensive or like a reverse iron condor. A riskier strategy is to hold a position through an announcement and see the implosion of the IV as a way to make money if the event was overpriced into the options price.

 

I hear you when you say you want to trade the fundamentals and there is some sense in that, however it would be unwise to believe you know more than people who are paid to do nothing but that all day every day. Therefore the understanding of biotech must be combined with options strategies that find a way to have a low cost exposure to your directional market understanding or a strategy that anticipates option behaviour based on your understanding of the timing of announcements and their relative importance.

[biotechpr@yahoo.com 0]

Hi, TrustyJules, thanks for your reply.

I do get paid to watch these stock every, that's the basic premise I am interested. And all your insights are quite right. Here's how it works.

There are around 500+ US listed biotech, not sure how many optionable and you would probably need to look at $300m+ in market cap to avoid nanostocks and zombie biotechs. You also need to avoid large biotechs and pharma (for this strategy specifically, I am interested in big ones as well, but that is a different game).

In order for the IV to spike decently, you need a clean story and a major catalyst. In other words, a drug that so far has a good R&D story, no skeletons in the closet and the upcoming catalyst is make it or break it for the drug or even the company. Typically, that is a small mid cap biotech with a proof of concept Phase II trial (mid-stage, c 40% probability of success) or even Phase III (final stage, c 60% of success, very rough, probabilities vary depending on therapeutic class and indications). Going into PDUFA dates (FDA approval), the R&D tends to be derisked (ie 90% of prob of success), but there are exceptions (like when the FDA decided to call an advisory committee, but these are low volume events).

I am interested most in Phase II/III trials, as that's where you can generate volume with decent R&D risk still remaining (as that's what creates uncertainty). You need volume because you would not want to put more 2-3% max into one position (much more less preferably), so you need consistently be exposed to 10+ events (which would still leave you with lots of cash, but presumptions is that portfolio level return would still be attractive).

That is where the first challenge from fundamental perspective comes into play. It is impossible to digest scientific data for that many drugs all the time and get some sort of insight whether there is chance this drug works or not. But to be honest, even if you have perfect understanding of all the data behind the drug, I do not think you could consistently call clinical trial win or loss (I am pretty sure about that actually). I think that is what you are referring to. 

However, that is not what is needed. You need to identify a clean, significant catalyst story. And this is easier if you have the right tools and skills. I think that by now I could relatively quickly assess whether the catalyst is genuine enough to cause IV spike. When it does, you often see the underlying appreciating. Fundamentally, I don't think I've seen stock selling off ahead of a genuine catalyst. The opposite, it tends to trend up 6-3 months in advance of the clinical trial read out. There could be profit taking ahead of the catalyst if the stock went up a lot. But as a part of this strategy, I would not be willing to hold into the clinical trial readout anyway. Not sure if it is possible at all to play an unknown direction large stock move and a collapse in IV.

So, identify a genuine catalyst within time horizon of 3-6 months and play stock remaining flat or rising, massive IV spike, then close the position ahead of the catalyst. I talked about fundamental challenge one above (identify a genuine catalyst). Challenge 2 is the right timing to close the position. Certainly before the catalyst, but they usually are guided quite roughly, eg Q1 or early 2023. Still, by that time assuming the position is profitable it should be possible to navigate.

Biopharmacatalyst.com was great (I think it was started by one guy). They sold it to big guys, so now paywalled. I have other tools for that. But the key is for me to judge whether it is a genuine catalyst and have sufficient volume to make the portfolio work from risk perspective. What I don't think I can do on my own just yet, figure out the best setups. 

[TrustyJules 3,212]

25 minutes ago, biotechpr@yahoo.com said:

undamentally, I don't think I've seen stock selling off ahead of a genuine catalyst.

nope - the stock in fact tends to be rather stable - up down and back to the middle - slight upwards trending

26 minutes ago, biotechpr@yahoo.com said:

o, identify a genuine catalyst within time horizon of 3-6 months and play stock remaining flat or rising, massive IV spike,

An IV spike doesnt take 3-6 months in fact in the analysis we did on the boards of SO its closer to a few weeks

27 minutes ago, biotechpr@yahoo.com said:

I am interested most in Phase II/III trials

In the experience we gathered before those are indeed good triggers as well as various PDUFAs

 

What you mention in terms of liquidity is relevant - some strategies like double call/put ratios dont work because there is too much spread on many small bio stocks. Some others it can work though SGEN for example is quite nice. The event, the strategy, the timing - it is all quite bespoke and requires a bit of information sharing and reflection. Ideally at least a month or so before things start going down, that way one can prepare.