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Portfolio Activity - CNCT

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Out of the Fire...and into the Frying Pan!

Just when we thought "all was well" with the world of options (our world is the OW Portfolio), an unexpected, earnings-related "plunge" occurred Wednesday. Shares of Connetics (NASDAQ:CNCT) dropped roughly 15% after reporting that first-quarter earnings fell to $1 million, or $0.03 a share, from $1.9 million, or $0.05 a share, a year ago. Even though revenue was $42 million versus $25 million a year earlier, investors focused on the lower-than-expected second quarter earnings outlook. In addition, Jefferies & Co. analyst David Windley downgraded the company to "hold" and lowered his 12-month price target to $25, citing concerns over the Food and Drug Administration's request for more information on preclinical studies of CNCT's acne treatment candidate Velac.

Since the share value "gapped" lower prior to the opening bell, there was no opportunity to make a timely exit in the position. With the issue currently
trading well below the sold (put) strike price, our alternatives are somewhat limited. Based on his or her personal outlook for CNCT, a trader might...

1) Close the play and accept the loss -- roughly $1250 for a 5-contract position.

2) Remain in the play in anticipation of repurchasing the options at a lower price, or accepting assignment in the underlying stock.

3) Roll out and down to a longer-term/lower strike put, selling additional contracts if necessary to offset the losses from the original position.

4) Transition to a bearish position, selling OTM calls or buying ITM puts to profit from addition declines in the underlying issue.

Considering the similar price pattern in late 2004, a trader could certainly make a case for remaining in the position. However, any recovery will likely take time, thus a viable "roll-out" strategy would probably focus (initially) on a 10-contract position in the JUL-$20 puts. If an adequate credit could not be achieved in the transition to that series, the OCT-$20 puts would be the next logical choice.

Another alternative would be to reduce the current loss in the position through the sale of some out-of-the-money calls. The JUN-$25 calls are trading for roughly $0.60, thus an investor who didn't mind owning CNCT could lower the overall basis in the issue to approximately $24.00 by initiating a short (call) position at that strike price. With this approach, the timeframe for a (expected) recovery is shorter and assuming a stock assignment in May, there are no adverse consequence to future upside activity. However, if the share value continued to move lower, a trader would have to write additional "covered" calls on the stock until a break-even basis could be achieved.

Obviously, there is no "magic" answer for this situation. Any action taken now should be based on your personal outlook for the issue and it's difficult for us to recommend an appropriate strategy without knowing your individual experience level, portfolio capital, risk/reward outlook, etc. Our current plan (if it can be called that) is to monitor the issue during the next few sessions to see if any buying support emerges. If the issue stabilizes near the current price, we may opt to roll forward to a lower strike (put) position. If not, we may simply close the play for the current loss and move on to another, more successful candidate.

OW Staff

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