OREX - Creating the Reverse Synthetic Convertible.

OREX's Contrave is set to be heard today by another FDA panel to discuss the drug's efficacy.
December 7, 2010 Endocrinologic and Metabolic Drugs Advisory Committee
Meeting - Webcast Information

The FDA plans to provide a live webcast of the December 7, 2010 meeting of the
Endocrinologic and Metabolic Drugs Advisory Committee.

Please note that the webcast will not display until the meeting begins at 8:00 a.m. EST on
December 7, 2010.

The webcast can be accessed here: https://collaboration.fda.gov/emdac/

I previously created a new design on the synthetic convertible that is an ideal play for this type of trade.    Again, necessity is the mother of all invention because my broker would not allow me to short OREX so I was forced to create the reverse synthetic convertible.

The reverse synthetic convertible is essentially the same play with OTC options with a long position in the stock versus a short.   This allows us to bypass the fact that we may not be able to short some stocks or ETF's and can also allow you to use your IRA to create some positions.   So let's create the trade from here.

We know that some volatility has been created with this news so it makes a great play  for my strategy.   So here is the trade (Reverse Synthetic Convertible)
     Short 20 Jan 11 OREX $7.50 Calls ($1.75 Avg)
     Long 1,000 OREX Stock ($5.43 Avg.)
     Long 7 Dec. OREX $3 Puts ($0.55 Avg.)

These trades were initiated on and around the 19th of November so the prices are somewhat different than today's information.    As you will also notice the difference in the Reverse and the normal Synthetic Convertible is simply the reverse of the original trade.   This makes complete sense because again remember that we are creating a new instrument and reversing the trades creates the same profile just in a different format.    The only changes that I have made to the original trades were sells of my original long (around 1,200 shares) to correspond with the appropriate delta on the call.   These trades allow me to create a better hedge and be in a better position when the event comes along.

www.synconvertguy.blogspot.com

HGSI Synthetic Convertible - The Perfect Trade (In Jeopardy?)

On Friday afternoon the FDA released notice that they were now delaying for 3 months their ruling on the approval of HGSI's lupus drug.   From my standpoint the approval or non-approval is not important.   What is important to me is the actual "event".    The "Perfect Trade" is somewhat hinged on the event itself and in no way reliant on the actual yes/no approval.    So does the delay itself actually derail the perfect trade?   The answer in short is "No".  

Please remember that we set the "Perfect Trade" in the following manner.
     Long 10 December $23 Calls ($2.80)
     Short 700 Shares HGSI ($24.90)
     Short 5 December $22 Puts ($0.75)

So let's retrace and analyze the options that we have at this point.    With the announcement of the delay in the FDA approval shares of HGSI immediately plummeted and it looked as though the market was adjusting the price accordingly.   Today however the price rebounding and at one point was actually higher but could not hang on and finished down for the down (HGSI $25.27).  

So let's assume that the price stays at this level - what does that do to our perfect trade?   We will still reap the $375 put premium regardless of the finishing price of HGSI.   If the price of HGSI were to stay at these levels we would lose the time value ($0.90) of the call options however would retain the intrinsic value by converting the calls to shares.   We could have the respective profit/loss from the short sale position.   

At today's closing price of $25.27, our "Perfect Trade" is essentially a draw.   If the options were to expire today we would have a losing position of ($414).  

At this point I think that it is still best to ride this trade out and capture some gamma from trading HGSI as the hedge against the call.   We have found the "worst case scenario creates a very small loss with essentially no gain.   At this point we can actively trade HGSI to make up the small loss on the options.

http://www.synconvertguy.blogspot.com/

 

HGSI Synthetic Convertible - Part 2

After my most recent post with the same title I received a very insightful comment with a question related to the trade on HGSI.   The question was "If there is a non-event for HGSI related to the December 9th FDA panel on HGSI's lupus drug or the meeting is postponed, will that not leave the "Perfect Trade" with a loss?"  Would we not simply lose the premium for the call option with no offset? The short answer to this question is Yes.   Let me explain.

The trade itself is set up for an "event" - the upcoming FDA meeting on the 12/9.   If there was no such  large event upcoming for a particular company then the "perfect trade" would be set up differently.   

Given a stock that is just plain volatile, like some other equities ETF's, the trade would be set up with a longer call option.   The premium outlay on the call option could then be offset for the most part by the steady stream of income from the short puts - if the stock price fails to exhibit the same levels of volatility.   If HGSI would continue to show the same volatility in stock prices then we would simply replace the short call (December) with a longer dated one (June/July).    This set up is much better suited for any equity or ETF that might have good consistent volatility versus the "event" scenario.

A very good actionable and long term trade would be to utilize the small cap ETF's (TNA. TZA etc).   Create the trade so that we can reap the benefits of the volatility however ensure that we can offset the premium outlay for the calls if the volatility goals are not met.   So here is an actionable trade to consider using the Small Cap 3X Leverage ETF (TNA).

     Long 10 Apr 11 $60 Calls ($14.20)
     Short 660 Shares TNA ($64.89)
     Short 4 Dec 10 $61 Puts ($1.60)

This trade will allow you to capture the volatility in the stock by trading the hedged short positions but will also allow the opportunity to offset the call premium OVER TIME with the income stream created by the monthly income from the short put positions.   

Great comment from "Animal".

http://www.synconvertguy.blogspot.com/