You Don't Have to Swing for the Fences With Every Investment in Small Caps

Last year, for the first time in its over 100-year history, there were more strike outs than hits in Major League Baseball. The New York Yankees broke the individual team home run record, a mark that had stood for decades. The Bronx Bombers might even break their own record this year if they can get healthy soon. Everything in baseball these days is about launch angle and home runs. Defenses have responded with massive shifts using data analytics and stockpiling 'live' arms in the bullpen, all of which can throw a baseball over 97 mph. The days of fundamentals like the hit and run and slapping the ball to the opposite field seem dead and over. Heck, if Bryce Harper and others like him knew how to lay a bunt down the third base line, they would stroll to first base given that the defense is selling out, playing a hit the other way. This would also help get rid of the shifts that have lowered their batting averages so significantly in recent years. I see the same behavior in the market, especially in the small cap biotech area where I spend most of my time writing about. Everyone wants the 'home run' but belly aches about the inevitable 'strike outs' that accompany this sort of investing. Everyone desires to be Giancarlo Stanton, few want to be Wade Boggs. Which is too bad. Mr. Boggs had an 18-year career, accumulated over 3,000 hits, hit over .325 lifetime, won a World Series and now resides in the Hall of Fame despite hitting a paltry 118 home runs. Just like baseball players would be better served playing more fundamental ball, investors would do better if they concentrated more on hitting consistent singles and the occasional double instead of swinging for home runs on every pitch in the small caps. The way I do that is by using buy-write option strategies. This consists of buying a stock and simultaneously selling a call option right near the current trading level of the stock. I find it is an effective method to initiate or build a stake in a small cap high beta stock. It can also be great for investor confidence, buying the big dips in the market like the one we just had in the fourth quarter of last year. I also find this strategy works well for 'special situations'. Take yesterday. Zogenix fell over 25% in early market action to approximately $39.00 a share. This plunge was due to a FDA action that should push back approval of one of the company's rare disease drug candidates by six to 15 months. A half dozen analyst firms reiterated Buy ratings after the FDA action, all with price targets in the $60s. Ironically, it was Morgan Stanley's reissuance of its Buy rating on GW Pharma that caught my eye especially the analyst commentary. We expect GWPH 'to be up at least 5-10% on the open following news that Zogenix was issued a Refusal to File (RTF) letter for Fintepla by the FDA. The RTF delays a potential competing product for Epidiolex for the treatment of seizures associated with Dravet Syndrome. While the Morgan's analyst lacks visibility, he would expect a delay of 3-6 months on the short end if Zogenix can use historic toxicity data and a delay of up to 15 months if the FDA requires new toxicity studies. That convinced me the sharp pullback in Zogenix shares on the FDA triggered delay was probably overdone. Using the October $40 call strike, I fashioned a buy-write on Zogenix for a net debit of $33 (stock price - option premium). If the stock trades at or above current levels come October, I will have garnered a just over 20% gain for my just over six month bet. If the stock trades under $40 a share then, I will have initiated a stake in a small cap name I like at current levels but for $33.00 a share. And that, is a solid 'double' in my book.

You Don't Have to Swing for the Fences With Every Investment in Small Caps

The way I do that is by using buy-write option strategies.

Columnist Conversation

Mr. Buffett Said: 'I couldn't find anything worth buying'

Thoughts on Stocks, Credit and the Reopening

Large CEO Buy Last Week in Essent Group (ESNT)

COLUMNIST TWEETS

Please Join or Log In to manage and receive alerts.