Friday, August 21, 2009
Biotech stocks are the most volatile in the world. One-day jumps of 200% and overnight crashes of 90% are commonplace. The biggest culprit behind biotech volatility? The United States Food and Drug Administration, the FDA.
Before ending up on pharmacy shelves, every new drug needs to pass through a series of regulatory hurdles dictated by the FDA. Without the FDA's blessing, a drug – no matter how great it may be – cannot make it to market.
So an FDA approval can help propel the stock 30% or more. A rejection could send the stock tumbling as much as 90%. Because of this, biotech traders love taking a position ahead of FDA rulings...
Which means next month is shaping up to be one of the most event-packed months for biotech traders. I've highlighted six major FDA decisions in the next month below:
For example, in September, the FDA advisory board will review Allos' cancer treatment, Folotyn, and Auxilium's hand-contracture drug, Xiaflex. The FDA typically follows the recommendation of the board. So a positive review likely means an approval in a few months, which will push both stocks up 20%-30% from here. But a negative reaction could hammer both stocks.
Of the approval decisions on the September calendar, I expect all four companies to receive final approvals for their respective drugs. And I expect investors can generate 10%-20% returns by owning the stocks ahead of the key dates.
But I know an even better way to trade these events...
As I mentioned, negative decisions – especially the "unexpected" ones – can send stocks tumbling 90% or more. In the ensuing frenzy, the market often dumps these stocks, which still offer plenty of value, without bothering to learn the reason for the rejection.
Thus, I am no fan of owning biotech stocks prior to important FDA decisions. A 20% return potential with a real prospect of a crash-and-burn is just not good idea.
Instead, I get most intrigued after these bloodbaths. Market overreactions create amazing opportunities.
In the S&A FDA Report, our 10-year backstudy of these events found investors can book 12% gains per year by blindly scooping up stocks in the days after the volatile FDA setbacks. If you can siphon out those with experienced management and decent pipelines, 50% low-risk gains are easily within reach as sentiment inevitably improves. This strategy soundly trumps any biotech index – or long-term S&P 500 returns – with way less risk.
The choice is yours – use the September trading calendar above to milk some volatility off FDA rulings before the event. Or simply wait for negative news before jumping in. I prefer the low-risk, no-brainer approach.
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