Alexander Valtsev
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Adjusting My Trade In Sarepta Therapeutics Like A Pro (And Making Money In The Meantime)

Sarepta Therapeutics's (SRPT) stock collapsed today as the FDA disapproved its newest product, the Duchenne muscular dystrophy drug. This is obviously bad news. The stock is down by over 25% as of the time of writing:
390246

The good news is that, despite the drop in the price of the stock, both of my strategies (read about the strangle here, read about the straddle here) are working. The market makers perfectly priced the risk, which is why the premiums collected from the sales of the strangle and the straddle cover the losses in the underlying. The options were expensive due to the pending uncertainty, which got removed in the morning today. As you would expect, implied volatility on the options has dropped substantially since then. This, of course, allows us to roll the trade and get some money off the table.

Here is what happened with the April 29th options:

(Source: Google Finance)

As you can recall, the $15 straddle cost $8.75 yesterday. Today, the straddles cost approximately $4.60 (we look at ask prices, as they would be the most relevant, if we bought the straddle back). The difference of $4.15 is our profit. On the other hand, we lost about $4 on the underlying (its price at the time of writing was $14.95). Hence, the net profit on the trade is about $0.15 per share. Not a lot at all, you would say, especially given the recent risk in the stock. I agree with that, which is why I suggest rolling the straddle to the next level, while remaining bullish on the stock. Here is the algorithm and the outcome of the trade:

(Source: author's calculations)

Note: the maximum loss is only possible if the stock crashes all the way to $0 in the next three days, which I consider highly improbable.

Essentially, this trade offers a successful exit from the previous trade (about a 13% return over the next three days, including the realized loss on the underlying). This is a likely scenario, unless the stock drops below about $9.50 per share (if the stock rises, we lose on the straddle but we win on the unrealized loss on the underlying from the previous trade. In other words, we don't care if it rockets).

You could say, "Why not simply hold on to the previous trade? Given the current market price of about $11 per share, we are still making money, aren't we?". On the one hand, this is correct. By keeping things unchanged, we save on transaction fees and still make a return. On the other hand, if the stock finished the week at the current level of around $11 per share, our return will be dismal (will cover the transaction costs, but that's it). With the update, we can still make ~13% in three days! The risk here is, of course, if the stock keeps going down and ends up below ~$9.50 per share on Friday.

Let us all keep our hands on this trade and learn more about risk and position management. Options are fun, and you should learn how to exploit their Greeks to your advantage!