Tuesday, May 15, 2012

SPPI: Speculating on drugs

Spectrum Pharmaceuticals Inc. (SPPI) develops and sells biotech products relating to the blood and cancers. Two drugs have won government approval in the United States and are on the market: Zevalen, used in radiotherapy to treat non-Hodgkins lymphoma, and Fusilev, used in treating bone and colon cancers.

The Henderson, Nevada company also has 10 drugs under development, two of them in late-stage development.

Pharmaceutical companies are more speculative than other sectors. They always carry the risk of regulatory shock. If the Food and Drug Administration disapproves one of the late-stage development drugs, then that will cause a downward price gap on the chart that could be of considerable magnitude.

SPPI had the most bullish chart of seven highly liquid stocks added today to the Zacks top-buy list. Actually, there were 47 stocks added, but I spent much of the morning rolling diagonal spreads and taking profits that I've run out of time to go through a list that long.

No big. The fact is that most of the stocks are too illiquid for me to trade. And as much as I love the exercise of running through charts, the practical work of trading must take precedence.

SPPI began its most recent leg up on April 16 from $9.50 and reached a swing high of $12.10 (so far) today.

In fact, is was only today that the price exceeded the prior high set on April 26. On that day, before the open, Spectrum reported a 155% earnings surprise -- that's what accounts for the high of $12.00 -- and the stock then plummeted throughout the day to a low of $10.47. I blame the plummet on the company's announcement that it was beginning a tender offer for all shares of a competitor, Allos Therapeutics, which trades under the ticker symbol ALTH.

But it's what happened next that gives me a positive view of the SPPI chart. After bouncing around sideways for seven trading days, the price began a steady rise that so far has lasted six days without a break.

SPPI's post-recession high of $16 occurred on Jan. 12. On the weekly chart, SPPI set a higher low in the recent correction must set a high above $16 prior to the next correction in order to keep the uptrend in place.

The price, if it continues to rise, faces recent resistance at $13.46 and $14.85. A retreat below the prior upswing high of $12.10 would stall the uptrend, and a drop below the correction low of $9.31 would suggestion that a downtrend is beginning.

Spectrum has a stunningly high return on equity of 50% with no long-term debt. Institutions ow 63% of the shares -- not a particularly high level -- and the price has bid bid up so that it takes $2.90 in shares to control a dollar in sales.

Quarterly earnings have tended to be all over the place. The 1st quarter of 2011 marked the end of a string of losses, and the company has been profitable each quarter ever since. Out of six quarters, four have shown positive earnings surprises.

On average SPPI trades 2 million shares a day. That's high enough to support a healthy selection of options with good open interest and narrow bid/ask spreads.

Implied volatility stands at 62%, in the middle of the six-month range, and has been in a gentle downward slope since the end of April.

Options traders are pricing in a 68.2% chance that the price will close between $9.92 and $14.41 a month from now, for a maximum gain or loss of 18%.

Spectrum next publishes earnings on July 30.

Decision for my account: This is a stock I would willingly trade if the price were higher. For low-priced stocks like SPPI, it takes a lot of options contracts to put together a position. For example, a short vertical spread (bull put spread) with about $1,500 in risk takes 25 contracts, and then slows fill times and increases trading costs. 

A covered call works nicely, providing about an 8% return from the sale of the option without a high contract count. But I'm looking for the greater returns that diagonal spreads provide.

So I'll pass for my account. But I think SPPI is a fine trade for someone who is interested in owning shares buttressed by call sales and/or insured by out-of-the-money puts.

I screened the stocks using a tourney bracket with a one-month daily chart and a three-day half-hour chart, and then turned to a five-year weekly chart for the broad context in analyzing the bracket winner. See my essay "10,000 Charts" for a discussion of my screening methods.

Tim Bovee, Private Trader tracks the analysis and trades of a private trader for his own accounts. Nothing in this blog constitutes a recommendation to buy or sell stocks, options or any other financial instrument. The only purpose of this blog is to provide education and entertainment.

No trader is ever 100 percent successful in his or her trades. Trading in the stock and option markets is risky and uncertain. Each trader must make trading decision decisions for his or her own account, and take responsibility for the consequences.

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