Dendreon (DNDN): Going Long Volatility

Dendreon (DNDN) will face the final decision by FDA on May 1 for its prostate cancer treatment vaccine called Provenge.  As recently as March 3, the management announced updated results of its 512-patient trial which showed improved three-year survival of patients with advanced prostate cancer by 40% compared with a placebo.  


One in every six men in the United States suffer from prostate cancer.  There is almost unanimous belief among analysts that Dendreon will have no problem getting FDA approval.  If approved, sales are expected to jump to as high as $2.5 billion by 2011.  


The trade I am contemplating here is going long volatility now while FDA decision is still more than a month away.  First, this is what we learned from AMLN, MDVN and ITMN:


Amylin (AMLN):
On Mar 15, FDA denied approval of Amylin's once-a-week diabetic drug called Byetta based on poor labeling.  No new trials were required, the company now expects to fix the language on labeling and re-submit.  One month before FDA decision, on Feb 12, AMLN March at-the-money strike IV was at 80.  Twenty-four hours before the decision the IV had skyrocketed to 261.  During this time, at-the-money $20 straddle went from $4.1 to $5.3 (up ~30%).  Theta decay did not matter.  


Better yet, you could've bought March 17.50/20 ratio spread on Feb 12 for $0.05 credit.  Twenty-four hours before the decision the ratio spread was going for $1.10 for nearly 45% profit (based on full margin requirement) all due to monster rise in IV significantly overcoming Theta decay.  


Medivation (MDVN):
On Mar 3, Medivation announced Phase III results of Alzheimer's drug called Dimebon that did not meet the efficacy endpoints and shares collapsed some 65% in one day.  Note that the management never gave out a confirm date for data release and for a long time they only suggested a time frame of either in Q1 or Q2.  Nevertheless, two months before the announcement on Jan 4, MDVN March at-the-money strike IV was at 105.  Twenty-four hours before the decision IV had skyrocketed to 270.  During this time, at-the-money $35 straddle went from $14 to $18 (up ~28%).  Theta decay did not matter.  


You could've bought March 35/40 ratio spread on Jan 4 for $3.65 debit.  Twenty-four hours before the announcement the ratio spread was going for $5.1 for nearly 30% profit (based on full margin requirement) all due to monster rise in IV significantly overcoming Theta decay.  


InterMune (ITMN):
On Mar 5, InterMune received preliminary indication of positive FDA decision when the company posted Briefing Documents online.  One week later, the company did get FDA approval seal for its lung cancer drug.  Just a little over a month before the decision on Jan 29, ITMN March at-the-money strike IV was at 90.  Twenty-four hours before the decision IV had skyrocketed to 360.  During this time, at-the-money $15 straddle went from $4 to $8.80 (up ~120%).  Theta decay did not matter.      


You could've bought March 15/17.50 ratio spread on Jan 29 for $0.70 debit.  Twenty-four hours before the announcement the ratio spread was going for $2.20 for nearly 60% profit (based on full margin requirement) all due to monster rise in IV significantly overcoming Theta decay.  


Takeaway:
The point of all this discussion is we have seen 3 biotechs with 3 distinct final outcomes (MDVN outright denial, ITMN outright approval, AMLN in the mix bag), but they all had one thing in common:  During 30-45 days before the final outcome, the IV rose so high overcoming Theta decay that whether you played with long straddle or long ratio spread, you would have made excellent profits and exited the position before the decision time.  


Will the history repeat itself for DNDN with FDA decision due on May 1st?  As of this writing, May IV is at 106.  Will it move above 200 or even 300?  If you believe it will, then I like the following ratio spread:

- Sell to open 1x May $25 call
- Buy to open 2x May $35 call


The ratio spread is going for net cost of zero (actually, the mark is $0.20 credit, but I have conservatively made it zero).  There are two charts here on the right.  The top one shows P&L as is using 106 IV.  The bottom one shows how P&L will change if IV goes up 100 to 206.  Notice how the white line changes between the two charts.  


The trade is meant to profit while IV is rising before the event and exit the position before the outcome.  However, the trade doesn't need to be closed before the event as long as you believe the stock will make greater than $10 move (right now straddle is pricing $12 move with IV at 106).  


I like the odds and will try for net cost of $0.00 on Monday morning.  


Good luck!