Orexigen Therapeutics Inc. (
) has come under heavy scrutiny lately, as the company prepares to
present its weight loss drug, Contrave, before a Food and Drug
Administration (FDA) panel next month. The company's competitors
have already suffered setbacks at the hands of the FDA. The
government agency denied Arena Pharmaceuticals Inc.'s (
) application for lorcaserin on Oct. 23, while VIVUS Inc.'s (
) weight management drug, Qnexa, was also rejected by the FDA in
Contrave goes before an FDA panel in December, with an official
decision from the FDA expected in January, which explains the
recent jump in call volume on the security. For instance, call
activity today has surged to more than 6.5 times the stock's
average daily call volume, with some 5,200 of these bullishly
oriented contracts changing hands so far. The most active contract
has been the December 7 strike, with nearly 2,000 contracts
crossing the tape.
Nestled amid OREX's call activity today, we find that one trader
is betting on a positive recommendation for Contrave from the FDA
panel. Specifically, 1,000 December 7 calls traded at about 11:03
a.m. Eastern time on the Chicago Board Options Exchange (
). These contracts crossed at the ask price of $1.60, or $160 per
contract, and were marked "spread." At the same time, 1,000
December 10 calls, also marked "spread," changed hands for the bid
price of $0.85, or $85 per contract. The end result is a vertical
call spread, more commonly known as a
, on Orexigen Therapeutics. This options strategy is also known as
a long call spread, or a bull call spread.
The Anatomy of an Orexigen Therapeutics Vertical Call
Breaking down this debit spread position, the trader purchased
1,000 December 7 calls for the ask price of $1.60, resulting in a
debit of $160,000 -- (1.60 * 100) * 1,000 = $160,000. If this were
a straightforward call play, the trader would need OREX to rally
roughly 52% from Friday's close at $5.67, to $8.60 per share, in
order for the position to reach breakeven at expiration.
Furthermore, the maximum loss on this leg of the position is
limited to the initial investment of $160,000.
As you can see, the second leg of the debit spread helps to
offset the cost of the overall position. In this case, the trader
sold 1,000 December 10 calls for the bid price of $0.85, netting a
total credit of $85,000 -- (0.85 * 100) * 1,000 = $85,000.
Combining this leg of the trade with the purchased December 7 call
lowers the total cost of the entire position to $75,000 -- $160,000
- $85,000 = $75,000.
The maximum profit is calculated by subtracting the initial net
debit of $0.75 from the difference between the two strikes, and is
reached if OREX rallies to $10 per share at expiration. In this
case, the maximum profit is $2.25 -- (10 - 7) - 0.75 = $2.25 -- or
$225 per pair of contracts. The maximum loss is equal to the net
debit of $0.75, or $75 per pair of contracts. Below is a chart for
a rough visual representation of the trade's profit/loss
After the vertical call spread has been entered, changes in
implied volatility are pretty much neutral to the overall position,
as it impacts the value of both the sold option and the purchased
option. At the time of the trade, implieds for the December 7 call
arrived at 323%, while the implied volatility for the December 10
call came in at 294%. Both readings appear to be heavily influenced
by the company's pending appearance before an FDA panel, as the
stock's one-month historical volatility arrives at a mere 60.85%.
With implieds bid extremely high, from an historical perspective,
there is the potential for volatility to decline sharply after the
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