It's time to study up on your pharma vocabulary as we once again look up a trade in Lexicon Pharmaceuticals (LXRX) .
After a years-long saga for this name, the Food and Drug Administration finally approved primary drug candidate sotagliflozin. This compound will go by the brand name Inpefa; it's a pill for patients with with heart failure, type 2 diabetes, chronic kidney disease, or other cardiovascular disease risk factors and is intended to cut the risk of cardiovascular death, hospitalization for heart failure, as well as urgent heart failure visits. In addition, Inpefa was granted a "broad label" use compared to competitors like Eli Lilly's (LLY) Jardiance and AstraZeneca's (AZN) Farxiga.
Thanks to the recent news, the shares of Lexicon now seem somewhat derisked and with the lucrative option premiums on the equity, it sets up well within a simple covered-call strategy.
This good news from the FDA temporarily lifted the shares, which had already risen into the FDA decision date. That rally was short-lived, however, as Lexicon did what most small biopharma companies do on positive news: It announced a capital raise. It gave word Thursday. So many investors tend to follow the adage "buy the rumor, sell the news" in this high beta space, and so, you can guess what followed. Lexicon raised just over $60 million of proceeds via a secondary offering at $2.60 per share. It was much needed.
On news of the green light for Inpefa, Citigroup reissued a "Buy" rating and $8 price target on LXRX. I am not nearly as optimistic as the initial stages of the marketing rollout are likely to be challenging given myriad competitors in the space. That said, FDA approval is a positive and should remove a long-term overhang on the stock. The capital raised increased the company's cash on hand to just north of $150 million, a significant portion of the shares approximate $650 million market capitalization.
Another thing I like about the company is that despite the challenges it has faced and the longer-term decline in the shares as it fought its way to eventual approval by the FDA, Lexicon's insiders never sold a share. If Inpefa can grab just 10% of its market, it will be a very successful drug. A potential marketing partnership with, or buyout by, a larger player is always a wildcard that would greatly boost the shares as well. Finally, Lexicon has a mid-stage drug candidate in its pipeline targeting diabetic peripheral neuropathic pain and postherpetic neuralgia that has some promise as well.
Add it all up, and LXRX seems to be a compelling, if high beta, "sum of the parts" story whose downside risk I can mitigate substantially using the following simple covered call strategy.
Option Strategy: Risk Reducing
To establish an initial position in LXRX using a covered call strategy, do the following: Selecting the January $3 call strikes, fashion a covered call order with a net debit in the $1.85 to $1.95 a share range (net stock price - option premium). This strategy provides downside protection of approximately 30%. This strategy also more than 50% of potential upside if the stock gets the slimmest of traction over the option duration.
(Please note that due to factors including low market capitalization and/or insufficient public float, we consider this stock to be a small-cap stock. You should be aware that such stocks are subject to more risk than stocks of larger companies, including greater volatility, lower liquidity and less publicly available information, and that postings such as this one can have an effect on their stock prices.)
