Alexza Pharma: Premium Selling Options Strategy

NEW YORK (TheStreet) -- Alexza Pharmaceuticals (ALXA) has a FDA drug approval decision date for its Adasuve treatment of agitation associated with schizophrenia and bipolar disorder on Dec. 21, 2012. Options currently imply of move of around $3 per share (up to $8 per share or down to $2 per share.)

Adasuve has faced a challenging path to approval and so the upcoming FDA decision, either positive or negative, remains uncertain. In situations where uncertainty is high and premiums are expensive, it is often a good idea to sell premium in a directionally neutral manner.

Here is the trade:

Sell (10) JAN 4.0 strike Puts at 0.95 = $(950)
Sell (10) JAN 7.0 strike Calls at 0.95 = $(950)
Initial P&L = $(1,900) Credit

This is a short Strangle sold for a credit of $1,900. Maximum profit occurs between $4 and $7 and is equal to the premium sold, or $1,900. The trade breaks even at approximately $2 and $9 - an extremely wide range. [See P&L Diagram below.]

The key risk in the trade is that the sold Puts and Calls are naked (i.e. they are not covered.) Risk can be quite substantial if the stock moves beyond what is implied by the options market, especially on the Call side of the trade.

Pelz has no position in Alexza.

To learn more about using options to trade biotech catalysts, check out Tony Pelz's book, The Biotech Trader Handbook.

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.