Name That Trade – $SNSS – Wee Pharma

by Dan February 13, 2014 3:12 pm • Commentary

I am going to do a couple things we rarely do at RiskReversal, take a request for a strategy, and detail options strategies on a small cap speculative biotech stock.  On Friday a friend from the business tweeted the following at me:

David’s firm Cowen is widely considered to be one of the best on the Street when it comes to Biotech stocks, and while I will be admit that I know less than nothing about the fundamentals of the stock, I was intrigued to look at a way to play with options in place of just owning the stock.

First things first, SNSS has a tiny market cap of only $250 million with about 10% of it in cash, net of debt.  As is the case with most small biotech companies before they get their big approval for their white whale drug, they lose a lot of money, 91 cents a share in 2012, expected to be a 72 cents loss in 2013 and .60 loss this year.  Sales, well there not a ton, a little over $7 million in 2013 and expected a big ramp to almost $21 million in 2014 (again I have no idea why the jump).

The largest holder is Fidelity with an 11% stake, and that’s a good thing. Short interest sits at about 14% of the float.

I would suggest that the technicals in a name like this don’t matter a whole heck of lot. You are stopped at zero and there is plenty of room to the upside.  But let’s take a little peak at the 5 year chart.  The stock spent all of last year above $4. That’s a pretty nice consolidation, with the obvious level of disaster support being above $2, where it spent a lot of time in and around mid 2010 to early 2012.  On the upside the high from April 2010 at about $7.50 could be a good near term target.

SNSS 5 year chart from Bloomberg
SNSS 5 year chart from Bloomberg

So if you were to buy the stock because you thought whatever data on whatever drug is due in Q3, you probably have risk to about 50% of where the stock is here, and the worst case down to about $1 which is basically their cash level.

Which leads us to looking if there is anyway to structure a trade that offers a superior risk reward. First let’s look at implied vol (IV), which as you would expect for a low single digit stock and money losing biotech is extremely high with 30 day at the  money IV in the 90s.  The 1 year chart below of the 30 day at the money IV shows it reaching highs.

SNSS 30 day at the money IV from Bloomberg
SNSS 30 day at the money IV from Bloomberg

Taking a look at the open interest in the name, it is clear that traders are driving up the price of upside calls with almost 22k of the open interest in calls and only 2700 in puts with the single largest lines of open interest:

– 6100 July 7.5 calls

-4800 July 5 calls

-2900 July 7.5 calls

-2800 July 10 calls

-2200 April 5 calls

You get the point. The asymmetric nature of the a stock like this has caused traders to prefer upside bets to downside ones, driving up the price of options, BUT there is one anomaly in the very few strikes that are listed in the stock that could present traders who are willing to be naked short puts an interesting play to the upside.

So if I were inclined to play long (which I am not, I know NOTHING about the company) here is the trade that would be very interesting to me.

VERY HYPOTHETICAL TRADE:  SNSS ($4.74) Buy Oct 2.50 – 5 /7.50 Call Spread Risk Reversal for a .40 Credit

-Sell 1 Oct 2.50 Put at .90

-Buy 1 Oct 5 Call for 2.50

-Sell 1 Oct 7.50 Call at 2.00

Receive .40  Credit for the Package

Break-Even on October Expiration:

Profits: between 2.50 and 5 receive .40 credit for the structure, or about 8.5% of the underlying stock price.  Between 5 and 7.50 make up to 2.50 of the call spread plus the .40 credit.  Max gain of 2.90 stock above 7.50, the full width of the call spread plus the credit received from the put sale.  The best case scenario would result in a 60% gain of the current stock price, with the risk being:

Losses:  Worst case stock is 2.50 or below and you are put the stock at that level, but you have received the .40 credit, so you have effectively bought it at 2.10, or down 55% from current levels.

Rationale:  While you would be giving away a good bit of the potential asymmetry of such a trade, this structure offers a much higher probability of success with in the money profit potential.