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Shorting Alexza Pharma On FDA's Adasuve Approval

NEW YORK (TheStreet) -- A true stock trader is agnostic, freely shifting his position in the same stock, going long or short, sometimes multiple times, whenever the situation warrants. Biotech traders profit most from this flexibility when biotech stock prices "run up" into catalysts and then "run down" after the catalyst passes.

The biotech run down most often occurs following an FDA drug approval. Recent examples include Exelixis (EXEL), Discovery Labs (DSCO), Vivus (VVUS), Arena Pharma (ARNA), Talon Therapeutics (TLON) and Horizon Pharma (HZNP). All of these stocks trade today at values substantially lower than their respective highs reached during the "run-up" into FDA drug approval. Just last Friday, Ariad Pharmaceuticals (ARIA) received early FDA approval for its leukemia drug and the share price dropped 20%.

Getting a drug approved by the FDA is an amazing achievement, so why do so many biotech and drug stocks fall following this happy event?

The answer, of course, is markets are forward looking, so drug approvals are often baked into stock valuations well before the event takes place. This is particularly true in cases where drug approval is widely expected. When drug approval is actually announced, stocks are already fairly valued. In worst cases, the run-up causes drug-approval stocks to overshoot on valuation. When this happens, profit taking can get manic as traders trip over each other to exit positions as quick as possible.

Alexza Pharmaceuticals (ALXA) is setting up nicely for a run-down trade ahead of Friday's FDA approval decision on the company's Adasuve therapy for schizophrenia agitation. I wrote a column on Nov. 20 recommending Alexza as a run-up trade and now it's time to reverse course.

The stock is trading at new highs following this week's decision by European regulators to recommend Adasuve for approval. Run-up traders locked in gains before the European decision was announced and now wait for the FDA to make its ruling known on Dec. 21.

Alexza's stock price is likely to sell off on news of Adasuve's approval by FDA. At these levels, the stock is pricing in FDA approval and unrealistic Adasuve sales. [Zacks analyst Jason Napodano's take on why Alexza is overvalued is a must read.]

How to profit from the coming Alexza run down: The most common method is to short Alexza shares on the approval spike and cover into the run down. I'd expect to see a price spike in Alexza following the Adasuve approval announcement, followed by multiple days where shares will close lower than they open.

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