A member this morning pointed out a trade on our Pharmaceutical lists of the highest-returning covered call plays: Dendreon Corp. (DNDN), a biotechnology company. On this morning’s April expiration list DNDN was shown at $21.78 earlier and it was possible to write the APR 20 Call for 2.90 in premium (5.1% return) and the APR 22.50 Call for 1.80 (8.2% uncalled, 11.6% called). Nice returns with only 12 days left until April expiration on 4/21. [The stock has moved almost 2.00 in the time it took to write this post, so many of the numbers in this post may be really old.]

But not so fast, let’s take a closer look.

After being essentially flat for two years and seldom being above $5 in the last year, this stock went up in late March like a bottle rocket, leaving anything resembling support (including moving averages and trendlines) far behind. There was a huge gap from about $5 to $12, and the last couple of days’ upmove has occurred on decreasing volume (although if volume continues at this rate, it might make a liar out of me), as the chart below shows:

(Click on the above chart to enlarge it)

DNDN moved up on an FDA panel’s endorsement of Provenge, Dendreon’s prostate cancer drug, although some have questioned the propriety of an FDA approval. Given the uncertainty of better news on this stock (and even with better news, does it have much further to go?) and the fact that it has spiked so far above support, it is a dangerous covered call write. See my archived newsletter on writing price spikes for more thoughts in this vein.

It is a small pharmaceutical company that loses money undergoing extreme current volatility, which breaks just about every rule of conservative covered call writing. The cost of protective puts for a covered call position is quite high, and the spread on the puts is enormous - the MAY 22.5P was 5.60 x 6.10 as I write, a bid/ask spread of 0.50. The stock is moving fast enough that it is hard to get option quotes consonant with the same stock price!

The stock may well not be able to hold this price level without more good news, like moving toward closer to FDA approval, which is uncertain. It may even fall on further good news in view of all the speculators who have already bought the rumor. I see this stock as a short - a straight put buy isn’t indicated because they’re far too expensive. Even the OTM MAY 20P is going for 4.90. Sell high premium, buy low premium, remember?

Speculators are having a field day. Putting a covered write on this stock is a real gamble. It might work, but your fingers will be crossed (and your knuckles likely white) waiting for April expiration.

This entry was posted on Monday, April 9th, 2007 at 12:57 pm and is filed under Covered Calls, Trading Tips, Technical Analysis. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.