For customers of many drug companies, whether or not to buy a product is often, unfortunately, not an elective matter. Customers who rely on drugs like Adderall to maintain steady concentration at work or school regard it as necessary, and that necessity has ballooned ADD treatment into a $4 billion industry. But not only is the demand picture permanently sunny for ADD drug manufacturers. For Shire plc (SHPGY), the supply situation is favorable at the moment, too.
As journalist Moe Tkacik reported earlier this month ("Pay Attention: The Great American Adderall Drought"), there is actually a nationwide shortage of Adderall, the most popular and effective drug for treating ADD. The shortage is apparently so severe that patients are having to drive into neighboring states and paying outrageous amounts to fill their regular prescriptions. Tkacik maintains that the Adderall shortage has been deliberately caused by Shire, the drug's maker. Because the Adderall patent expired in 2009, Shire now faces the prospect of cheap generic drugs from competitors like Teva Pharmaceutical (TEVA) and Impax Laboratories (IPXL). Those other companies are currently buying Adderall XR (extended release) from Shire while producing their own instant-release generic alternatives. The theory is that by stockpiling the XR drug instead of selling it to competitors, Shire can make them look foolish or unreliable. Additionally, Shire has a new Adderall alternative, Vyvanse, that is more expensive and is under a new patent; if it can push customers toward Vyvanse it will increase profit margins while also buying itself many more years as the market leader. Finally, the regulatory details surrounding DEA approvals for amphetamine production mean that the Adderall shortage may not be only for the short-term. All together this amounts to a plausible case for being long the stock, even if the reasons are perhaps perverse from a public health perspective.
Trades: Buy to open SHPGY January 80 puts for $1.05 and sell to open SHPGY January 85 puts for $1.80.
Since this is a risk-defined trade already, we don't need an additional stop loss in place. From an implied volatility perspective, the options we are trading are priced at 30% annualized or above, which is an average level compared with the last two years of IV history -- but if the bullish thesis is correct and Shire is able to profit from a market it controls, these options will look like a desirable sale in hindsight.
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