A good lesson from the biotech sector
Today's Financial News - Posted February 9, 2009
Shares of ViroPharma (NASDAQ:VPHM) are plunging by as much as 50% today because of bad news out of a clinical trial. Investors that owned the shares without a protective strategy are out of luck. But the folks smart enough to protect their investment with options are up as much as 400%.
By Andrew Snyder, TodaysFinancialNews.com
Baltimore – (TFN): Whenever an investor hears a CEO say the words “disappointed and extremely surprised,” he should brace for share price recoil. And when those words are uttered by an executive at a tiny biotech firm, be prepared for utter catastrophe.
The nation’s small drug research companies are at the mercy of clinical trials and the FDA. If bad news leaks from either one of the sources, a speculative company’s future is at stake. Investors could lose half of their position, if not more, in just a few hours.
That is exactly what happened to ViroPharma (NASDAQ:VPHM) investors this morning. After the company received “disappointing and surprising” news out of a pivotal Phase III trial, share price was cut in half. Investors went into the weekend holding shares that were worth $12.21 each. Right now, they can trade them for just $5.94 in cash. Not a great way to start the week.
Here’s what happened:
The company developed a drug called maribavir, designed to reduce deadly infections in patients undergoing bone marrow transplants. The drug made it all the way to Phase III clinical trials, the last major hurdle before reaching the FDA’s decision makers, where it failed to outperform a placebo treatment.
The virus maribavir was designed to treat is cytomegalovirus (CMV), which is living inside 50% to 85% of us. In healthy people, the virus is rather mundane. Most people never know they have it. But as soon as their immune system is compromised, like when they undergo bone marrow treatments, the virus turns deadly.
Portfolio killer
If ViroPharm finds some way to make maribavir a successful drug, it will not be the first company to beat CMV, but it will be the first to do it without much of the toxic side effects of other drugs. It would almost certainly be the first choice of prescribing doctors.
While this news is devastating to the company’s investors, it gives outsiders a glimpse of the true volatility of the biotech world. Over the next few months, as Obama starts writing checks to the industry, companies like ViroPharm will get lots and lots of attention.
Scores of the firms will make investors big-time gains. But just as many will clear savings accounts. The clinical trial process is a risky and expensive ordeal for fledgling companies. It truly is a make-or-break situation.
A company like ViroPharm can easily spend $400 million or more on the FDA’s rigorous process, just to have results like the ones we received today. That figure does not include the millions of dollars spent on research and in-house testing. Needless to say, it is a risky, expensive process.
But, if success is achieved, huge profits can be had. It makes the sector very attractive to speculative investors, the folks that can afford to chance 50% or more of their principal for the opportunity to double or even triple their money. Over the next few months, there will be plenty of opportunities.
What about those of us trained in a conservative school? How can you take advantage of the reward without all of the risk?
Learning a good lesson
That is a good question and, again, one that will be asked a lot. Anytime you eliminate some or all of an investments risk, you will give up at least a portion of the money-making potential. That is why Treasury bills pay such a pittance. They are the ultimate risk-free investment… for now.
Over the years, I have used options as the best way to mitigate risk in the biotech industry. By using smart call or put selection and doing your homework, you can lower your risk to just 5% or 10% of your initial investment and keep your profit potential in triple-digit percentages.
For proof of the potential. Just look at ViroPharm’s February 5 Puts (DUZNA). They are up by 400% today. Investors that protected their downside with this simple insurance policy are sitting on big-time profits, even as the equity side of their position plummets.
There are all sorts of ways to protect from a share price avalanche. In fact, in just a few weeks, TFN will be introducing a new trading service that specializes in exactly what I am talking about. But more on that later.
For now, take a look at your portfolio and dig out the at-risk investments. Today is a perfect day to enter the options market and make a few protective investments. It is simple and effective.
You may never need the insurance, but if you do, you will be glad you made the move. It could save your wealth.
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