Options Update: Option Players Align Ahead of Elan’s Trial Results

• July 29, 2008
• Mark Fightmaster

It’s A Long Way to Tysabri

Pharmaceutical firms are in the news today, as Amgen garnered early attention thanks to Friday’s release of trial data. Other news attracting attention to the pharmaceutical sector may be released by Elan
tomorrow. The firm is set to present midstage study data with Wyeth (WYE) on the firms’ Alzheimer’s disease treatment (bapineuzumab) tomorrow at the International Conference on Alzheimer’s Disease in Chicago. If the data is favorable, it may give a hint as to what would be realized in a larger-scale investigation. ELN’s drug works by clearing out a type of plaque that kills neurons in the brain, which is believed to be the root of Alzheimer’s (the plaque).

Tomorrow’s news comes on the heels of last week’s earnings announcement, which indicated that sales of multiple-sclerosis drug Tysabri helped trim the firm’s quarterly loss. ELN saw its loss narrow to 15 cents per share from 30 cents per share a year ago. This announcement was the impetus for a rebound off the 32 level and a march higher for the shares.

The combination of tomorrow’s news event and last week’s earnings report have prompted heavy activity in the options pits. It is this action that has caught my eye today.

According to today’s Intraday Volume Explosion List, ELN has seen heavy activity on both sides of the sentiment divide. On an average day, slightly more than 5,000 total puts trade on ELN – this number has increased nearly fourfold today. A good portion of this activity is centered on the August 29 contract (EDK TA), which is rather far out of the money at the moment. On the call side, total volume is more than twice the norm, with most of the activity focused on the out-of-the-money August 35 call (EDK HG). Taking this activity in conjunction with the news event tomorrow, it certainly seems that option players are trying to strangle ELN a day in advance.

While my initial belief was that we were dealing with a potential strangle, I can’t confirm my suspicions thanks to the dreaded “late” designation. However, the timing and size of the transactions suggest that my initial reaction may have been (*gasp*) correct. At 10:08 and 10:12 AM EST, corresponding blocks of 5,000 crossed on EDK TA and EDK HG.

Taking the prices supplied for the transaction times, our hypothetical “strangler” would need ELN to advance past $37.65 or drop past $28 to break even. Setting the stock price at $34 (the nearest whole number), this means the stock has to advance 10% or drop 18% for the option player to break even. That’s a big drop, but it does exactly what a strangle should do: allow the player to capitalize in a big move in the underlying stock, no matter what the direction.

A Chance to Get Healthy

Analysts and option players alike afford a chance for the stock to get healthy. As for analysts, Zacks indicates that 4 rate ELN a “strong sell,” 4 rate it a “hold,” and 1 feels the firm is worthy of a “strong buy” designation. This configuration leaves the door open for upgrades, which could serve to lend momentum to ELN. Facing tomorrow’s news, bulls should find the ratings skew to the bearish comforting. The chance for momentum-squashing downgrades is nearly nil, while the bearish tendencies leave the door wide open for upgrades.

If you are bullish on ELN (especially short-term bulls trying to capitalize on a news event), the sentiment from option players should be comforting. The drug firm’s Schaeffer’s put/call open interest ratio (SOIR) of 0.94 is higher than 87% of those taken during the past 52 weeks. This accumulation of bearish bets affords a chance for pessimism to unwind and apply the requisite buying pressure to the stock.

Healthy Performance

As a contrarian, I like the way the sentiment shapes up toward ELN – decidedly bearish. For the true excitement to start, I need to see solid technical performance in the face of this sentiment, as we could see the stock jump as pessimism unwinds. Of course, the unwinding of the pessimism depends on the flavor of the news.

I noted that I would like to see solid performance, and ELN actually obliges. Since January 1, ELN has gained 53%, indicating the ability to weather the current environment. If you would like to see longer-term strength, you can; ELN has tacked on slightly more than 77% during the past 52 weeks.

Yes, the stock is pulling back a bit, and has slumped nearly 4% during the past 4 weeks – but it could be considered a buying opportunity. The stock seems to have found a bit of support in the form of its 10-week moving average, which provided a floor to the pullback last week. The equity has finished below this trendline, but that doesn’t mean that it won’t continue to hold up like it did last week.

The thing is, our hypothetical strangle player wants the stock to make a quick move in either direction by August expiration. Remember, we are looking for a 10% jump higher, or a 17% slide – both rather sizeable moves. While the downside move is the toughest to believe will come to fruition, there is hope for the upside move. Currently, 6% of ELN’s float is sold short, meaning that there is a slight chance for a short-covering rally if tomorrow’s results are stronger than expected. Such a rally could topple the 36 level once and for all (and it will have to, in order to make money for our option player).

The Verdict?I can understand why someone would be bullish toward ELN in either the long- or intermediate-time frame. That said, this stock hasn’t displayed a consistent flair for dramatically quick moves. Yes, it jumped at the end of June, but let’s not forget – that was a month ago. Let’s see what happens tomorrow, as investors stare down the opportunity for a Fast, Aggressive move in (hopefully) the Right direction. The short-term chances for a jump aren’t squarely against such a scenario unfolding – but the chances seem small that we will see a 10% or 17% jump to either side tomorrow.

If you have any questions or comments, make sure to email me. I will do my best to answer your question or address your concern.

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