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DNA Is An "Options" Obsession

Tuesday, 27 Jan 2009 | 5:11 PM ET

Not since the first OJ Simpson trial has America been so captivated by DNA.

Of course, the DNA in question here is the not subject of a Watson and Crick book, but instead the stock ticker for biotech behemoth, Genentech .

In July, Roche bid $43 Billion, or $89 bucks a share for the remaining part of Genentech that it did not already own. The offer is a play on DNA's roster of oncology drugs, including its blockbuster Avastin, which recorded $2.7 billion in sales in 2008.

But almost as soon as the offer came out, some investors were looking for more.

"Roche's initial bid was only 10% more than where DNA was trading at the time. We've seen better bids for inferior assets," said Geoff Porges, equity analyst over at Sanford C. Bernstein & Co.

Roche may also be fighting time. In April, Genentech is set to release trial results for Avastin use in colon cancer patients. Roche may be forced to pay more if that trial is successful, putting more pressure on the company to close now.

"If the April trial is successful, that could force a higher bid," Porges added (Porges rates the company "Outperform").

Perhaps that's why Genentech has seen such bullish activity in the options market.

Case in point: the March 90 and 95 calls. Last week, the big volume centered on those two contracts, as investors bought the March 90 calls and sold the March 95 calls, placing a bet that Roche will raise its $89 bid. By buying the 90 calls, investors are betting DNA shares will rise above that level. But by selling the 95 call, they're capping their upside and suggesting that they don't see a bid higher than $95 anytime soon.

"Option prices suggest that there is a 30% chance that this stock finishes above $95 by March expiration," said Stacey Gilbert, Options Action star and market strategist at Susquehanna. "Clearly investors think there's a chance Roche has more to offer. And if you're going to play a stock for a takeover, options are your best bet."

Gilbert makes an interesting point. If one were inclined to play DNA purely on the hopes of an increased bid, plopping down $8,300 for 100 shares seems like an awfully big risk, especially when the most optimistic scenario involves only a $95 dollar offer - only six bucks more than the original bid.

But by buying Genentech's March 90/95 call spread, an option investor would only be wagering about $1.30 (paying $1.90 to buy the March 90 call - collecting $.60 to sell the March 95 call) for the chance to make $3.70, or the difference in the strikes (5), minus the cost of putting on the trade ($1.30). Note, these prices are as of 3pm today.

So, let's do the math: spend $8,300 to make a potential $1200, or spend $1.30 to possibly make $3.70.

For an update on this trade, be sure to tune this Friday night for "Options Action" at 11:30 pm ET.

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