Investment Overlay – $CBST – It’s Probably Just a Phase 3

by Enis November 21, 2013 11:23 am • Commentary

CBST was our inaugural investment idea for RiskReversal, executed at the start of November.  The full post details our thoughts on the company and the stock.  We concluded with:

As we’ll do with all our longer term investment trades we’ll look to manage this position using options as we know more about the timing of trials and other events in the company’s future.

CBST has rallied up to near its all-time highs over the past few weeks.  Implied volatility is priced quite high as traders anticipate the release of CBST’s phase 3 data of Ceftolozane/tazobactam for Complicated intra-abdominal infections (cIAI) and complicated urinary tract infections (cUTI) 2H 2013.  Here’s the volatility chart for CBST:  

[caption id="attachment_32830" align="alignnone" width="600"]CBST 30 day implied vol (red) vs. 30 day realized vol (blue), Courtesy of LiveVolPro CBST 30 day implied vol (red) vs. 30 day realized vol (blue), Courtesy of LiveVolPro[/caption]

Market participants expect a good bit of volatility due to the Phase 3 trial data, so implied volatility (red) is near the highs of the year even though realized volatility (blue) is quite subdued recently.

We do not know what the outcome of the event will be, but we want to collect some of this highly priced premium against our existing long stock position in CBST. So here’s an overwrite:

 

INVESTMENT OVERLAY:  Against Long 100 shares of CBST (currently 64.75, purchased for 61.84) stock, sell 1 CBST Dec 65 Call at 3.80

 

Trade Rationale:  If CBST closes above 65 on Dec expiration, then our long stock position will get called away (though we can adjust the trade in the future if we want to keep our stock position).  However, if CBST closes below 65, we will have collected the extra premium and would remain long stock, thereby reducing our cost base on our long stock position overall.