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Buy Straddles On This Extremely Volatile Stock

Immunomedics, Inc. is a clinical-stage biopharmaceutical company developing monoclonal antibody-based products for the targeted treatment of cancer, autoimmune disorders and other serious diseases. The Company's technologies allow it to create humanized antibodies in unlabeled or naked form, or conjugated with radioactive isotopes, chemotherapeutics, cytokines or toxins. Its product candidates include 90Y-clivatuzumab tetraxetan. It is reporting earnings on Wednesday, August 17, after market close:

As evident from the above, the company beat earnings estimates in 13% of time in the last eight quarters, underperforming or showing in-line results in 87% of time, and has seen substantial volatility in the market price of its stock over the last three month:

The market participants expect the following numbers over the next few quarters, including the upcoming one:

(Source: TD Waterhouse)

Market data show that the August options are a bit undervalued:

(Source: TD Waterhouse)

The four-week straddles (options with a strike price of $2.50 or $3.00 and expiring on September 16, 2016) are worth around 17.8% of the current market price of the stock. Historically, the stock has been more volatile than that on a monthly basis over the last year:

(Source: Google Finance. Calculations by author)

As you can see, the stock has had a monthly standard deviation of 22.2% over the last 52 weeks, while the straddle expiring in four weeks has an implied monthly volatility of around 23.3% (calculated based on 18 business days remaining until expiration), also including volatility from the earnings event this week. I therefore see signs of modest undervaluation in these options. Hence, buying the straddles is a good idea from a theoretical standpoint:


The risk-return profile of this trade looks like this:


As you can see from the above illustration, the "window of safety" is around 54.0%. This means that the stock has to move roughly 27.0% in either direction from the current price by expiration in order for investors to start making money. I think that given the cheapness of the trade and the volatile past of this stock, this trade is very interesting. You can also think about selling out-of-money options to help fund this trade.

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