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UPDATED Vivus (VVUS) Option Trade for July 17th PDUFA

publication date: Jul 15, 2012
 | 
author/source: Steve Johannsen

Vivus (VVUS) Option Trade for July 17th PDUFA


By guest author Steve Johannsen @SteveJo22

 

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Note: Check with your broker to ensure your current level of options approval will allow you to execute

this trade. Before placing any options trade it is important to consider how much you are willing to risk.

100% loss with options is possible (I typically risk 1-5% of my total account depending on my conviction).

The following is my trading idea/thoughts and is not a recommendation to buy or sell.

 

Vivus PDUFA for QNEXA is July 17th and approval is widely expected based on a three month delay to

finalize a REMS program. With approval likely priced in, traders will be reacting to the magnitude of the

REMS program and the wording in the final label.

 

July options expire three trading days following PDUFA and I expect VVUS to react similar to other

drug approvals with an initial pop and rundown. Implied volatility (IV) is >250% which means options

are expensive. The option chain is pricing in a potential move of ~$8 using the at the money straddle

estimate ($19-35).

 

In trade scenarios where options are expensive it is generally better to write them rather than purchase

them. I am trading VVUS with a trade structure called an Iron Butterfly. This is essentially a short

straddle that is hedged to the downside and upside so that maximum risk is defined when the trade is

executed.

 

The risk of the trade is for a major unexpected move to the downside (CRL, harsh REMS) or upside

(surprise partnership) that exceeds the profit boundary.

 

An Iron butterfly is traded in as a net credit to your account and profit is realized by buying back one or

both of the short options with the hedges expiring worthless. I chose the $25 strike price as my target

and hedged with the $16 put and $34 call.

 

The Iron Butterfly structure I am using looks like this:

 

$16 Put: 1X (Buy as downside hedge)

$25 Call: -1X (Write) 

$25 Put: -1X (Write)

$34 Call: 1X (Buy as upside hedge)

 

 

Notice that this trade profits anywhere between $18.20 and 31.80, with maximum profit achieved at

$25. (At the time of writing I have filled 5 spreads at 6.80 credit and plan on adding a few more)

 

Rational for a $25 Target

 

Valuation calculations for obesity companies are incredibly difficult to model due to an extremely large

potential market that is significantly affected by small changes to the variables. Constructing a model

is worthless until there is real market data on sales to base projections on so I will assume the market is

correct at this point.

 

VVUS traded between ~$20-25 following the 20-2 positive advisory committee vote. On April 9th when

the FDA notified Vivus a of three month extension to finalize a REMS program the stock ran from ~$20

to $26.50 (this was essentially notice of approval). Hype from Arena's drug approval and general bio

mania resulted in another run reaching a high of $30.22. With biomania fading the $25 target sits right

in the middle of the 20-30 pre-PDUFA trading range. On approval if VVUS pops to the recent high of

~$30 and runs down ~4-6% each day that would give ~$25 at July options expiration.

 

 

Another important factor to consider in that the max pain for the July option series is the $25 strike. The

theory is that on option expiration the share price will move in the direction that brings maximum pain

to option buyers.

 

http://www.option-calc.com/optioncalc/?symb=VVUS&exp=201207

 

Insiders arguably have the best idea of the companies value and since February 2012 insiders have sold

$36M worth of shares between $20 and 28. Insiders have also sold shares at $25-28 during the month

of June and July ($12.5M worth from a 10b5-1 plan established in March 2012). 

http://www.secform4.com/insider-trading/881524.htmI

 

On June 19th Vivus CFO gave an presentation and QA session with analysts.

http://cc.talkpoint.com/well001/061912a_hr/?entity=50_12FOSMK

 

During the session Timothy Morris discusses the likely REMS program, including only mail order

pharmacy for distribution, no direct to consumer advertising for at least the first year, and a >10K

patient CVOT trial. He also talked about the plan of 150 sales reps targeting 25K specialists, which

hints that no partnership is in discussion. I believe that the average retail investor is unaware of these

restrictions on VVUS.

 

I decided on a $25 target because believe that since approval is widely expected the market is pricing

in the best case label and REMS program. A tougher than expected REMS along with a likely black box

warning label will result in a reality check following approval and we should expect the typical pop

followed by rundown.

 

Example Profit Potential Assuming a Risk of ~$2000 (9 spreads) on July Expiration

(Share price, ~profit) 

$23, $4400

$25, $6100

$28, $3400

 

Final thoughts

I heavily considered centering this trade on the $27 or $28 strikes and I may add it depending on how

VVUS trades on July 16th. Please remember to consider your risk tolerance and the potential for a

100% loss. Plan your trade based on how much you are willing to risk and not on how much you can

potentially profit. Good luck.

 

Once again, If you haven't already signed up for Options House stop reading and open an account immediately!

http://oh.tellapal.com/a/clk/28K8f

 

Update (16 July 2012)

During the day today I decided to add five additional Iron Butterfly spreads this time centered at $28

(wrote $28 put and call and added to my $16 put and $34 call hedges).

 

$16 Put: 1X (Buy as downside hedge)

$28 Call: -1X (Write)

$28 Put: -1X (Write)

$34 Call: 1X (Buy as upside hedge)

 

My combined position is now: 

$16 Put: 10 @ 1.11 avg

$25 Call: -5 @ 5.80 avg

$25 Put: -5 @ 3.07 avg

$28 Call: -5 @ 4.23 avg

$28 Put: -5 @ 3.66 avg

$34 Call: 10 @ 1.02 avg

 

This structure gives me a $3 range of maximum profitability ($25 to28). My actual combined PnL in

graphical form:

The combined trade now profits between $20.25 and 32.75 although has a much greater loss to the

downside.

 

Note: My total commission with Options House to fill both of these trades was only $31. If you would

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