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Dynavax: Speculative Upside Options Trade

Stocks in this article: DVAX

NEW YORK ( TheStreet) -- Dynavax Technologies (DVAX) shares fell 50% last week on a mixed vote from an FDA advisory panel for its hepatitis B vaccine Heplisav. Experts on the FDA panel voted favorably on Heplisav's efficacy but negative on the vaccine's safety.

Mixed FDA panel votes often make excellent trading set-ups for the subsequent approval decision. The FDA is not required to follow the panel's recommendations, so you'll often see speculators attracted to beaten-down stocks on the chance that regulators overrule and approve. Never underestimate the potential upside of these stocks no matter how dire the situation appears.

The FDA is expected to announce its approval decision for Heplisav on February 24. Dynavax's stock price is definitely beaten down due to the mixed panel vote and the company has enough cash on hand -- all requisite ingredients for a potentially powerful run-up into the FDA approval decision.

One way to play this situation using options is to implement a risk reversal, that is, selling a Put to finance the purchase of a Call. Here is the trade:

Sell (10) JAN 2.5 Puts at 0.35 = $(350)
Buy 10 MAR 5.0 Calls at 0.25 = $250
Initial P&L = $(100)

This risk reversal is not standard as it is structured specifically for Dynavax's Heplisav FDA decision. Basically we are selling the January expiration Puts to finance the purchase of March expiration Calls. (An alternative would be to buy two times the number of Calls than sold Puts.)

The logic of this structure is that we expect or assume some price support (or potential run-up) into the February decision. Stocks with near-term catalyst often display price support. Assuming the shares trade above $2.50 by January expiration, this trade profits on the Puts, as they would expire worthless.

At that point (after January expiration), the trade owns free Calls to benefit risk free from any potential upside thereafter, including a guaranteed profit position of at least $100 regardless of what happens.

Downside of this trade is if Dynavax shares for any reason plummet below $2.50 prior to January expiration. The stock had an after-hours print of a bit below $1.70 following the FDA panel vote so that can act as the initial downside risk target for a catastrophic scenario. If the shares trade a bit lower than $2.50 by expiration, we maintain the option to be assigned the shares with a perfect follow-on trade of selling the February 2.5 strike Calls against the long stock position. These expire prior to the Feb. 24 FDA decision date, thus are a great way to play a covered Call.

Pelz has no position in Dynavax.

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 Pelz currently resides in Denver, Colorado where he trades for his own account.

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