Bye Buy Biogen

BIOGEN-IDEC'S SCIENTISTS TRY TO SOLVE the riddles of science with chemistry. They have created drugs such as Rituxan for certain B-cell non-Hodgkin's lymphomas, and Tsyabri and Avonex for multiple sclerosis.

Options traders, meanwhile, try to solve the riddles of the financial market by using options pricing models to uncover pricing discrepancies and hidden opportunities not recognized by others.

Citigroup's analysts have applied the rigor of options analysis to Biogen at a time when investors are hotly debating if it will finally be bought by another company.

The stock is up 42% year-to-date, yet doubts are emerging that the stock may be too pricey even though the company has said it was for sale. The stock has declined on investor skepticism about finding a buyer, but Citigroup's analysts believe a deal announcement could come within two months.

To monetize this view, the firm's options strategist, Mitchell S. Revsine, recommends investors buy January 75 or 80 calls to position for the deal.

In a note Revsine published with Yaron Werber, who follows Biogen at Citigroup, the analysts said they believe Pfizer is the top contender to buy Biogen.

Pfizer has expressed a desire for biologics manufacturing capacity. The analysts further support their trade thesis by citing Pfizer's looming losses of some exclusive drug patents in 12 to 18 months, and an expressed interest in developing an 80/20 revenue split between small- and large-molecule treatments.

Meanwhile, the analysts said they understand other contenders, including Roche of Switzerland and Johnson & Johnson, may not be really interested in Biogen, and only participated in the bidding process to get a good view of a biotech company's operations. This is not bad, in their view, and they wager the likelihood of a takeover at 70%, but the lack of other bidders also lowers the acquisition premium. Thus, the analysts lowered Biogen's target price to $85 from $87.

The options market, which is essentially a giant probability model, is not as optimistic about a Biogen takeover. Biogen's options prices suggest a 50% takeover probability, and options pricing indicates that the stock, recently trading at about $70, may only move $9, compared with Citigroup's view for $13.30.

If investors use options to speculate on Biogen's acquisition, here's how the payout might look if the stock is at $85 by the time the January 75 calls expire. The call would have a 132% return on capital, and the January 80 call would have a 127% return. Of course, if the analysis is wrong and Biogen stock trends lower because it is not taken over, call buyers could lose all the money spent on buying the calls.

Still, options are probably the best way to trade this potential takeover. If a deal fails to materialize, the stock will decline and no one knows by how much. At least with options, the losses are known at the onset.