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ISIS Pharmaceuticals Trader Expects an Extended Decline

Breaking down a bear put spread on beleaguered ISIS

by 10/18/2012 9:29 AM
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So far this week, the shares of ISIS Pharmaceuticals, Inc. (NASDAQ:ISIS - 9.62) have shed nearly 24% amid regulatory concerns. The stock is now flirting with five-month lows, and is trading south of its 200-day moving average for the first time since late April. What's more, the shares are halted today as a non-FDA panel reviews the company's new drug application for Kynamro. Against this backdrop, one options speculator is rolling the dice on more downside once ISIS resumes trading.

During the course of yesterday's session, ISIS saw about 20,000 puts change hands -- roughly seven times its average daily put volume. Around midday, symmetrical blocks of 1,700 contracts traded at the October 8 and 9 puts, both marked "spread." The 8-strike puts crossed at the bid price of $0.25 each, suggesting they were sold, and the 9-strike puts traded at the ask price of $0.70 apiece, implying they were likely bought. Since open interest increased at both strikes overnight, it appears the strategist constructed a bear put spread for a net debit of $0.45 per pair of puts.

By purchasing the October 9 puts to open, the trader is expecting ISIS to extend its recent retreat through the end of the week. However, in order to trim the cost of entry -- which represents the maximum risk -- and the breakeven rail on the bearish trade, the investor sold the lower-strike puts. Now, the strategist will reap a reward if ISIS breaches the $8.55 level (bought put strike minus net debit) by tomorrow's closing bell, though the sold puts cap his maximum reward at $0.55 (difference between strikes minus net debit), no matter how far ISIS should fall beyond the $8 level.

Had the trader simply bought the 9-strike puts, ISIS would have to breach the $8.30 level (strike minus premium paid) before he'd reach breakeven. Plus, his maximum risk would be $0.70, should the stock stay north of $9. However, his profit would increase with each step south of $8.30.

Currently, ISIS' front-month options are relatively expensive, thanks to escalating demand ahead of today's regulatory review. In fact, the equity's Schaeffer's Volatility Index (SVI) now sits at 127% -- above 50% of all other readings of the past year, suggesting short-term contracts are more pricey than usual right now. As such, and since October-dated options have very little time value right now, it's no surprise that the aforementioned option bear hedged his bets by selling the October 8 puts.

Plus, puts have been especially in demand -- likely thanks to a pre-panel FDA briefing that noted an "unexpected" level of concern regarding Kynamro's potential carcinogenicity. What's more, that same panel reportedly voted to recommend approval of a rival drug from Aegerion Pharmaceuticals, Inc. (NASDAQ:AEGR) just yesterday.

On the International Securities Exchange (ISE), Chicago Board Options Exchange (CBOE), and NASDAQ OMX PHLX (PHLX), the stock's 10-day put/call volume ratio of 1.21 stands just nine percentage points from a 52-week peak. In other words, option buyers have initiated bearish bets over bullish at a near annual-high clip during the past couple of weeks.

Meanwhile, the rest of Wall Street is also somewhat leery of ISIS. Fewer than half of the analysts following the stock consider it worthy of a "buy" or better rating. Plus, short interest accounts for nearly 10% of the equity's total available float, and would take more than eight sessions to unwind, at ISIS' average pace of trading.

At 7:30 p.m. ET tonight, ISIS will conduct a live webcast conference call to discuss the outcome of today's Endocrinologic and Metabolic Drugs Advisory Committee (EMDAC) meeting.


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