Exelixis: New Drug Approval Options Trade

NEW YORK (TheStreet) -- Exelixis (EXEL) is expecting to hear from the FDA about an approval decision for its medullary thyroid cancer drug cabozantinib by Nov. 29. The Exelixis trade I posted several weeks ago postulated that the shares would trade around $5 before the FDA approval decision date and thus far that's been correct. The trade has been a winner on a percentage basis.

Now that December options are available, there are new ways to trade the upcoming cabaozantinib catalyst. (November options expire before Nov. 29 so the focus now shifts to December expiration options.) Here's the new Exelixis options trade:

Buy 10 DEC 4.0 strike Puts @ 0.35 = $350
Buy 10 DEC 5.0 strike Calls @ 0.60 = $600
Initial Trade P&L = $950 Debit

This is a bullish DEC 4/5 strangle with a total risk of $950 should Exelixis trade between $4 and $5 by expiration. Regardless of stock price direction, I expect (implied) volatility to increase substantially from current levels -- from 95 to 180 (feel free to ridicule me if I am wrong.)

This expected increase in volatility should by itself provide 10-20% upside in the premium by the FDA decision date -- thus there is some embedded optionality in the trade structure should I decide to exit the trade the day prior to Nov. 29. If I hold through that date, I need the stock to increase or decrease by 95 cents above or below the $5 strike Call or the $4 strike Put. Thus, the trade's breakeven points are $5.95 or $3.05 by DEC expiration on Dec. 22.

Pelz has no position in Exelixis.

To learn more about using options to trade biotech stocks, check out Tony Pelz's book, The Biotech Trader Handbook or subscribe to Chimera Research Group.

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.