I was out having a coffee a few hours before the market opened Tuesday at my favorite coffee place here in downtown Miami (not Starbucks) with a friend. Karl is an ex-Brooklynite who now splits time between Miami and London. We were engaged in our favorite topic. The ascendancy of the Evil Empire (AKA, my beloved NY Yankees) and the fate of his miserable Mets, who look more like a M.A.S.H. unit than a baseball team for the third year in a row.
We were in the middle of a hypothetical trade scenario that made sense for both teams around the Mets' ace pitcher Jacob deGrom, when I got an email notification that T2 Biosystems (TTOO) was trading up 10% in pre-market as the FDA approved their new bacterial panel. Karl was quite happy with the news as he had taken my advice and loaded up on the shares in the mid-$4s several months ago and now the stock was trading near $10 on the news.
My first reaction was to ask if he had sold covered calls on a good portion of his holdings as I suggested late the week before. He looked at me quizzically and perplexedly inquired if this wasn't great news for the stock. I stated that it was fantastic news for the company as they now possessed a product that could reduce the time to test for Sepsis into hours from the current standard process. This will cut drastically the amount of time needed to detect and treat this deadly bacterium that kills tens of thousands every year in hospitals throughout the United States.
Source: T2 Biosystems
It was also great news for long-term shareholders and probably increased T2 Biosystems desirability as a potential buyout target significantly as well. However, the shares had also run up some 50% in the three weeks leading into this approval. Historically, this in most cases means after the initial euphoria of the positive news wears off, the stock will see some "buy the rumor, sell the news" trading behavior usually that same trading day.
In addition, small developmental firms like T2 Biosystems often use these sorts of run-ups on positive events to raise additional capital via secondary offerings. Indeed, that is exactly what happened with TTOO Tuesday. The stock gave way to its initial bout of enthusiasm early in trading and ended up down 9% on the day. The company then announced a secondary offering right after the market closed, knocking the shares down another 7% percent in after-hours trading.
I ran into Karl in our building's gym several hours later. He was beaming ear to ear. I asked if he had time to sell out-of-the-money call options against his holdings at market open. "Yep, I got some nice options premiums against my stock as well. Happy hour is on me." My reply was "Let's make it Capital Grille."
The lesson of this little story is that this sort of option strategy should be every investors' "tool box" that invests in biotech given the high-beta nature of the sector. This is a great way to mitigate some risk and the option premiums are usually more than solid. Or as Real Money's Jim Cramer is fond of saying, "Bulls make money. Bears make money. Pigs get slaughtered."
(This column originally appeared May 30 on Real Money Pro, our premium site for active traders and Wall Street professionals. Click here to get great columns like this each day.)