Neurochem Play: Up or Down or Either Way

Neurochem Inc. (NRMX) is a small Canadian biotech company that focuses on neurological diseases. Neurochem has a market cap of about $600 million, $50 million in cash, and $34 million in debt. The company has yet to take a drug to market, but they do have one drug that is nearing an FDA decision and another drug that just completed phase III.

Data from Neurochem’s phase III trial for Alzhemed, a treatment for Alzheimer’s, is due out sometime in May. Neurochem is also awaiting an FDA decision on Eprodisate, a treatment for Amyloid A amyloidosis, which should come by April 16.

The combination of these two events has sent Neurochem’s May option premiums soaring. Although both the puts and the calls are expensive, the options are telling us to expect negative news as the puts are significantly more expensive than the calls. Although Wall Street Mayhem doesn’t really have an opinion on Neurochem’s stock, the large option premiums and the discrepancy between the prices for the puts and the calls have created a good trading opportunity in Neurochem.

By shorting the stock, writing the puts, and buying the calls we have created a net neutral position that should perform well no matter what happens to the underlying stock. The key to this trade is locking in a profit between the price of selling the puts and buying the calls. In this case we gained $0.90 after selling the puts and buying the calls. If Neurochem announces negative data about Alzhemed, the stock will go down significantly. If we hold these positions until expiration with the stock down, the puts we sold will get exercised at $15 which closes out our short position and nets a gain of $0.25 on the short position. With the stock down at expiration, the calls will expire worthless, but the total position will have a net gain of $1.15 or about 7.5% of the net outlay required for this trade.

If Neurochem announces positive data about Alzhemed, the stock will go up significantly. In this scenario, at expiration we exercise the calls closing out the short position at $15 dollars creating a net gain of $0.25 for the short position. With the stock up at expiration the puts will expire and the trade will gain $1.15 or 7.5% of the initial outlay.

If Neurochem’s stock stays flat (unlikely considering the pending news and big option premiums) this trade still works out well. If the stock closed at $15.25 at expiration, we could still exercise the calls and close out the short position for a $0.25 gain brining the net gain back to $1.15 or 7.5%.

Athough it may be difficult to find Neurochem shares available to short, this is a great trade if you can get your hands on some shortable shares. If you have a direct access broker try calling and asking if there are any available shares to short even if the standard trading interface does not show that any are available.

Suggested Trades:

* Short Sell NRMX near $15.25

* Sell to Open KQMQC.X (NRMX May $15 puts) near $5.80

* Buy KQMEC.X (NRMX May $15 calls) near $4.90

NRMX 1-yr. chart:

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