KITE January 18 Call an Option Worth Considering

Investment Analysis Clubs Saul’s Investing Discussions
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All-
I know this is not an option board, but I thinks it’s worth considering a SMALL amount of an options at times. When you see a singularly focused company with a binary event coming, owning an option can be lower risk than owning a stock. I think KITE is an excellent example.

KITE Pharma:

Business: Kite has a cancer therapy supercharging a persons own immune system to fight off cancer. It’s formally known as CAR-T or chimeric antigen receptor T-cell therapy. KITE’s drug, KTE-C19, has a success rates of 52 - 91% with no deaths. Juno Therapeutics is in the same field, but had to pull its lead drug because they caused brain swelling and deaths in 4 patients. KTE-C19 has not had those problems (so far), and it’s drugs are the only option for people with aggressive non-Hodgkin Lymphoma.

Binary Event Sometime during the 1st quarter 2017, the FDA will approve the application or ask for more data. If they do not get approval, my guess is that the stock would drop by ~50%. If they do get the approval, I think the stock will go up 250 - 500%.

Valuation SWAG Kite’s current market cap is $2.5B. As a comparison, Celgene’ Revlimid, J&J’s Imbruvica, and Amgen’s Blincyto run $300,000, $320,000, and $450,000 respectively. Kite estimates 7,400 patients annually so the total value of the therapy using $350,000 as an estimate is $2.6B. If we assume 50% margin and a 25 PE ratio, KITE would eventually be valued at about $32B. Assuming we could capture 50% of the market capitalization this year, we would be looking at a 540% increase during the year.

http://www.mmm-online.com/commercial/kite-pharma-to-keep-ant…

Strategy If I were to purchase this stock, I would have a maximum of 1% of my portfolio in it. My guesstimate for chances of failure is 40%. My guesstimate of a maximum loss is 50% (they have other drugs in the pipeline). My approach is to buy a Jan 2018 Call at $50 strike price (near the current stock price). The cost of the option is about 25% of the stock price. If the drug fails to get approval, I am out 0.25% of my portfolio. Unpleasant, but not a killer to my return. If the drug is approved, I could earn 3 - 5% more on my portfolio which is a pretty nice addition to a yearly return. I think the trick to using this approach is:

  1. Purchase limit options as if the contract = actual shares. I recommend a portfolio allocation of 1% so if 300 shares = 1% of your portfolio, purchase 3 contracts.
  2. Make sure the position has a better than 50% chance for success.
  3. Only use this strategy for Phase 3 testing or in applications in being evaluated.
  4. Be ready to kiss 0.25% of your portfolio goodbye. worst case, it is still better than losing over 0.5%.

I really like this company so if the NDA works out, I will convert my gains into actual stock and hold onto it for a while. My goal is to get into this stock at a LOW price with minimal risk.

Best,

bulwnkl

PS One of the better biotech analysts, Eric Schmidt rates KITE a buy, and TMFBiologyFool and TMFEBCapital seem to like it too.

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Sometime during the 1st quarter 2017, the FDA will approve the application or ask for more data

First of all thanks for bringing up your idea. It is certainly different than the normal discussion, but certainly appreciated too.

What is your reasoning for going out to Jan '18 instead of Jul '17 given the decision is supposed to happen in Q1? Is it just to give the trade a little more time in case the FDA “drags their feet?”

You can buy the July $50 call for $9.30 instead of $12.50 for the January '18 call.

What gives you the impression KITE has a 60% chance for approval?

Take care and thanks,
A.J.

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A.J.,
Several things make me think that their is a 60% chance of success.

1.There is no approved therapy that works on the patients tested. This is important because there are no drugs to compare efficacy/safety too. This is a naturally lower hurdle.

  1. Extremely good efficacy results. The group tested was unresponsive to the first line treatments, BUT in the Zuma-1 trial 76% had a positive response and 43% went into complete remission. The FDA tends to give a treatment like this more safety attitude because many patience would be dead without this so if there were some fatalities the risk would likely be worth it.

  2. There have been zero safety issues reported so far CAR-T therapies rely on a preconditioning step as well. Juno Therapeutics failed their CAR-T studies, but had different preconditioning chemotherapy treatments. The preconditioning treatment is believed to be related to the safety problems.

  3. The company believes their data is strong enough to seek accelerated approval from the FDA. That doesn’t typically happen with questionable data

To answer your questions, “why did I buy the January call?” This is both a therapy and a biomedical process. The FDA has to be comfortable with all of it so I wanted a little extra time if there is a hiccup. It’s a small price to pay if that time is needed.

Best,

bulwnkl

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If you have a binary event with explosive upside, looking at the

July 70’s at $2 or so may make more sense. If the stock doubles

on an FDA approval, the July 70’s pay off 15x. If in fact the chance

of approval is 50/50 thatis great odds

Just another way to look at it

JK

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Yup. You’re right. Because there is a process involved with the therapy, there could be a number of things that the FDA could do to restrict things so read up, and take a look at a strike price that works for you. Please consider keeping your allocation small if you want to give it a go.

Best,

bulwnkl

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Great idea bulwnkl, and a clutch addition from JK. I have never been interested in pharma or really any healthcare because it just seems so…well, as you said, binary. This seems like a perfect way to limit the downside and give yourself plenty of upside if you are correct. You don’t even need to be correct that often. Even if the chances the stock doubles are 10% you’re still +EV if you get $2 July $70’s. The ask I’m seeing is 3.50, though. 3.20 for the $75’s. What am I missing?

Bear

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My bad

I just looked at last on Yahoo, which was 2,25

The bid ask spread is brutal on options!

The scenario remains the same, the math a bit different

If you decide to try this put your bid between the bid and ask

and move the limit towards the ask until the fill occurs

Generally this should allow you to buy the option in the spread.

I would size it small also, it is more a bet than an investment

JK

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Those of you talking about the July options are presuming the news will hit before then. Recall Bulwnkl thought it would be best to go out to January.

I looked at $85/$90 strikes as well. Obviously, once you begin getting that far out of the money the leverage becomes incredible. But you are forgoing potential upside if the market has a more muted reaction that bulwnkl’s 2.5 to 5.0x hypothesis.

And yes, the spreads are huge as I’m sure these options aren’t terribly liquid. In my experience, mid-point is a pipe dream in those instances. You’ll watch your order move the bid ask spread.

I was showing the mid-point of the July $70s at $2.58 but that is all after market stuff. Again, July doesn’t allow for potential FDA foot dragging.

Take care,
A.J.

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“Biotech + Options” is far too speculative and akin to gambling for me.

I get your argument, but there is such uncertainty in clinicals, even in phase 3. I’d be more comforted if they had an on-going base of income from approved leading products. Add to that ambiguities such as unrevealed side-effects; patient life quality; patents; and a management team with uncertain depth bringing products to market.

If I was to game this one based on your numbers, I’d go with a long 40/60 April strangle.

I hope you make a killing on your KITE trade.

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Roy,
Look at my goals and ask yourself is it truly gambling? Since my goal is to eventually open up a long-term position that I want to hold for several years. My point thesis for the option is:

  1. I am very optimistic about approval.
  2. I am concerned about time with the FDA, and think that April might be cutting it too close.

Since we both don’t like risk, we could agree that if I purchased 1% stock, there’s a good chance that I could loose 50%. That’s why I limit the allocation to no more than 1%. By buying a January 18 Call, I reduced the time risk over April by 9 months and limited my total risk to 0.25% of my portfolio, which less than I would have by purchasing the stock outright. Since my goal is to buy and hold the stock for the long-term, I consider this less speculative than buying the stock outright. Now, your approach limits the downside further to 0.1%, but it also reduces my upside. Another way to reduce risk is to make several small, well studied “bets” over time and let the shear numbers work in your favor and keep your costs as low as possible.

Either way would probably work.

Best,

bulwnkl

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Look at my goals and ask yourself is it truly gambling?

Not for you, but for me it’s different because…

I am very optimistic about approval.

… and I’m not and I’ve been close enough to this industry to anticipate that approvals seldom go forward as intended. More often than not, more data is requested or the indication approval is narrowed. And yes, your January expirations can buffer some of that turbulence.

I’m not saying you are wrong… only that I won’t be there alongside you. Maybe you’re closer to this company than I realize, but I’ll find my returns elsewhere. I’m allocated in this industry already with CELG.

I truly hope your results put me to shame.

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Well I have been and will be wrong many times, and for the bulk of my portfolio I focus on established business. At the end of the day, our returns will be close. Celgene is my fourth largest holding :slight_smile:

Best,

bulwnkl

PS. What line of work are you in optics? electrical engineering? analytic chemistry?

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If anyone is still holding some (very profitable) options on KITE, I would suggest changing them to (less leveraged) KITE stock sooner rather than later. You are in a very leveraged position with options, and the very stretched rubber band could snap back $10 or $15 any time (even Monday) and still have had a huge response to last weeks news. Just a little caution.
Saul

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