Sarepta Therapeutics (SRPT), the maker of eteplirsen, an experimental treatment for Duchenne muscular dystrophy (DMD), had quite a run.  Based on a small phase II study showing that its drug prolonged walking for six minutes in boys and increased production of the dystrophin gene, the company had hoped to get approval from the FDA. There were two amazing aspects to its application - the number of subjects (only 12) and the statistics (of the 12, two subjects were considered 'outliers' and discarded from the analysis). 

Based on the small number of patients and the two outliers, I felt strongly that the NDA would not be approved. However, the market seemed to have other ideas, with bullish articles on SeekingAlpha.com as well as TheStreet.com.  I could have shorted the stock, but was concerned that the irrational market could continue for a lot longer than I could remain solvent in a short position if the stock surged to $60 or even $70 a share.  Therefore, I used an options strategy.

I bought SRPT at $47/share, bought Jan 2014 puts and sold Jan 2015 covered calls at the $47 strike price. The rationale was this: if the stock continued to rise, my calls would be called in and the stock gone (i.e., I would keep the premium on the calls, but not gain anything on the stock). The puts would trade lower and I would lose money on the puts.  Thus, I would make money on the covered calls if the stock price went higher. My plan was for the amount I made on the covered calls to exceed the amount I lost on the puts. However, if the stock dropped, I would make money on both the [sold] calls and [bought] puts, and lose money on the stock.  Here is how it worked out.

Bought 400 Stock ($19,013) - sold 4 Calls ($6,243) + bought 4 Puts ($ 2,430) = $15,200

On November 12, the FDA rejected the application, calling it premature. Worse, it said that the endpoints were not acceptable, and that Sarepta would have to come up with new ones.  Naturally, the stock plunged, all the way to around $13 and change.  I sold my positions, with these results:

Sold 400 Stock ($5,530) - bought 4 Calls ($390) + sold 4 Puts ($12,572) = $ 17,712

Gains were $5,843 on the calls and $10,142 on the puts.  Loss was $13,483 on the stock.  Overall gain was $2,512, or 16% in two months.  Annualized gain would be about 96%. I have used this strategy in the past with Vivus with equally good gains.  For momentum biotech stocks, this is a safe and reasonable strategy.

As for Sarepta, at this point I would not bother with it.  Till the phase III is well under way, it will remain a dead stock (assuming it has the money to carry out the yet-to-be-designed phase III study).