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Trading Biotech With Options: Exelixis

I expect Exelixis shares to continue trading between $4 and $6 (but mostly around or below $5) before November expiration (Nov. 17) due to the back-and-forth selling and buying pressure between underwater shareholders, convertible bondholders and new speculators.

Investors can take advantage of this Exelixis situation by executing the following options trade:

Sell (10) NOV 4.0 strike Puts at 0.35 = $(350)
Buy 10 NOV 4.0 strike Calls at 0.75 = $750
Sell (20) NOV 5.0 strike Calls at 0.30 = $(600)
Buy 10 NOV 6.0 strike Calls at 0.15 = $150

Trade Initial P&L = $(50) Credit

This is a Credit Call Butterfly -- that is, I am actually being paid to put on this position (not much, $50 for this size, but still being paid nevertheless.) The position involves buying a Call Butterfly (see above) and selling a Put to fully finance the cost. The key risk is obviously to the downside since we sold the Put. Unless negative data comes out prior to November option expiration -- or the company unexpectedly announces a delay or other negative news -- I would expect Exelixis' share price to remain above $4 given the impending Nov. 29 FDA drug approval decision date.

Obviously, I could be wrong. Maximum profit for this trade size is $1,050 if the shares trade to $5 by expiration and this profit tapers off between $4 and $6. (See the P&L diagram.)

If the stock trades below $4 by Nov. 17 expiration I will be assigned the shares (1,000 shares for this size trade) and be positioned to either hold into the possible run-up, sell 4.0 strike DEC Calls against the shares (i.e. trade into a covered Call) or simply remove any risk and sell them.

Pelz is currently long Exelixis shares.

Follow Tony Pelz on Twitter.
Tony Pelz was a trader on a major European bank's proprietary trading desk, responsible for a portfolio with limits of more than $200 million. Prior to proprietary trading, Pelz worked with several global investment banks in roles ranging from corporate finance, M&A to credit and business development. He is author of The Biotech Trader Handbook, 2nd Edition, co-founder of the small-cap biotech research and trading site Chimera Research Group and operator of PelzOptions.com. Pelz currently resides in Denver, Colorado where he trades for his own account.
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