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Human Genome Sciences Perks Up

Shares of the biotech firm rally amid a sharp spike in options activity. Is an FDA ruling coming?

Editor's Note: The following is an exclusive reprint of market commentary posted at Schaeffer's on March 1.

Over the past few days, option activity has been unusually heavy on biopharmaceutical concern

Human Genome Sciences


, most notably on the put side.

Since Monday, put open interest in the March and April options series has grown by 14,341 contracts, or 29%. Call open interest, meanwhile, has risen by 8,670 contracts, or 13%. This imbalance has pushed the stock's Schaeffer's put/call open interest ratio (SOIR) from 0.75 to 0.86, moving from the 82nd to the 92nd annual percentile. In other words, rarely has the short-term speculative crowd been more bearishly aligned.

On Tuesday, put volume was strong on the March $12.50 strike (HQI OV), where 3,906 contracts changed hands, the lion's share of which translated as new open interest. Volume was also notable on this option's counterpart; the March $12.50 call (HQI CV) saw nearly 7,700 contracts cross the tape, about 3,700 of which became new open interest in the light of day. Both of these front-month options saw a variety of small and midsized blocks change hands, implying that this trading was probably not the work of major institutions.

Implied volatilities are currently fairly rich, compared to historical standards. The three-month historical volatility for Human Genome Sciences' options stands at 46%, while the 10-day historical volatility reading is 58%. In addition, slightly out-of-the-money calls are priced with an implied volatility around 79%, while slightly out-of-the-money puts have an implied volatility price tag of nearly 89%.

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Historical volatility is a statistical measurement of a stock's past price movement over a specific time period. The assumption of the underlying equity's stock's volatility is an important variable that helps determine an option's price. Since all other factors in the options pricing model (stock price, strike price, etc.) are assumed to be known, the implied volatility is always the lone wild card. In the case of Human Genome Sciences, implied volatility measures are well above historical averages. This suggests two things; first, that investors are expecting a dramatic move from the stock and secondly, that options players are willing to pay an above-average premium to purchase Human Genome options.

Turning away from the options trading world to other sentiment indicators, short interest is relatively robust, representing more than 11% of the equity's float. At the stock's average daily volume, it would take more than four days for all of the existing short positions to bail out. And short interest has been escalating since April 2004, rising 250% over the past 21 months.

Technically speaking, Human Genome Sciences has been in a choppy mode for years, spending most of its time since early 2003 between the $8 and $14 levels. Over the past few weeks, the stock has been surging higher with help from its 10-week moving average and is now advancing toward the top rail of this range. Wednesday, the stock gained 6.8% without any news to account for the move. In recent trading, the stock was $13.19.

Something Brewing in the Lab?
Shares of Human Genome Sciences have been perking up lately

Source: Schaeffer's Investment Research

Implied volatities are pricey, option activity is notable and the stock is making hasty moves without any rhyme or reason. Short interest is a wild card -- a slight short-covering rally isn't out of the question, but there is always room for additional bears. The company took its turn in the earnings confessional in early February, so I'm wondering if there are rumors of impending action from the Food and Drug Administration. Human Genome Sciences is currently working at pushing five drug candidates through the testing and regulatory pipelines, so it's possible that some eager options players think news might be emerging sooner rather than later. And these players are willing to pay dearly for a shot at some action.

Bernie Schaeffer is Chairman and CEO of Schaeffer's Investment Research, Inc. and author of The Option Advisor: Wealth-Building Techniques Using Equity and Index Options. Bernie has edited the Option Advisor newsletter since its inception in 1981.

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