Using these two extreme values (50 cents and $28.56), one can calculate a probability weighted fair value for Celsion stock ahead of the binary event. The general formula for the model is:
Fair Value = Price_success x Prob._success + Price_failure x (1 - Prob._success)
For example at Red Acre we believe that, optimistically, the HEAT trial has a 20% chance of success. Therefore fair value would be calculated as the sum of the probability weighted extreme values i.e.:
Fair Value = 20% X $28.56 + 80% X $0.50 = $6.11.
Working From These Numbers
Our simple model for fair value helps determine whether the risk of being long the stock is justified by the probability weighted outcomes of the binary event. To work from our model, one can adjust either the extreme values (our estimate of $28.56 on positive news is likely overly optimistic in the short term), or the probabilities of success and failure.
One useful way to work with these numbers is to calculate the implied probability of success given a certain price level of the stock. For Example, Celsion closed at $8.18 on January 25th. Using our extreme values of $0.50 and $28.56, the $8.18 price implies a 27.4% probability of trial success.
Another useful analysis to perform is to look at what the price should be on a successful outcome if the current price reflects an equal probability of success or failure. At $8.18, if the market is considering the HEAT trial as having a 50/50 chance of success or failure, the implied price of Celsion upon a successful outcome is $15.86.
It is interesting to note that during the bear raid on January 16th, Celsion stock traded as low as $6.17 -- close to our own estimate of fair value at $6.11. In other words, those who managed to buy shares at the lows of the bear raid got a good deal because their shares were purchased at a fair valuation based on our assessment of the risks.
This simple model helps determine situations where a stock has reached unrealistic valuations ahead of a binary event. Different investors will have different numbers for both the price levels on success and failure and for the probabilities of the trial succeeding or failing. The model is flexible enough to accommodate a wide range of scenarios with a minimum of inputs. While more complex models based on discounted future cash flows etc. could be produced, at Red Acre we prefer simple models that let us identify stocks where the correct trade is abundantly clear.
In the case of Celsion, the current price of $8.11 does not favor a long position given our estimate of the probability of losing most of the principle invested in the trade; however, it is clear that an at-the-money call strategy would allow one to capture potential upside while minimizing capital invested. Celsion option premiums remain very high and we do not recommend this trade except for entertainment purposes. Treat it like a lotto ticket and enjoy the ride regardless of the outcome of the trial results.
Our mission at Red Acre Investments is to provide actionable analysis on binary events, special situations, and mispriced securities. To take advantage of our analysis and Get Ahead of the Curve, sign-up today.
Disclosure: Author Rajesh Patel, Ph.D. of Red Acre Investments is not a registered investment advisor and the views and opinions offered herein do not constitute investment advice. Investors should always conduct their own due diligence before trading. You should assume that Red Acre is trading the securities mentioned, generally in accordance with the views we express, although their positions may change as news evolves. They do not undertake any obligation to update our views as market conditions evolve.
The full version of this report can be found at both BioMedReports and RedAcre.Com.
Healthcare investors and Biotech traders interested in accessing BioMedReports' new complete database of clinical trials and upcoming FDA and world-wide regulatory decisions which can be used to make more profitable trades and see upcoming catalysts can go to: http://biomedreports.com/fdacal.html
News developments and live healthcare sector updates are available constantly via Twitter at: http://twitter.com/BioMedReports
BioMedReports is a news and research portal covering financial biotech news for the entire Healthcare Sector of the market. BioMedReports is not paid or compensated to report the news and developments of publicly traded companies. BioMedReports sells a premium product for subscribers and full disclosures and information about the stocks and news mentioned in this news release are available at BioMedReports.Com
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