Nektar’s 40% drop yesterday was an extreme over-reaction: What I’m doing now

It’s never good to turn in disappointing results in a drug trial–as Nektar Therapeutics (NKTR) did over the weekend–but to whack 40% off the stock price on this news is an extreme over-reaction.

To justify a 40% drop you have to assume 1) that the results were worse than they were, 2) that all Nektar’s drug candidates have flaws in their trials, 3) that Bristol-Meyers (BMY) will lose faith in Nektar and demand its $2 billion back, and 4) that Nektar’s new non-addictive opioid, that it did submit to the U.S. Food & Drug Administration in May for approval as promised (granted the company submitted the drug on May 30) won’t gain approval.

I think what we’re witnessing is the weak hands and momentum players, who got into Nektar only after and because of its 387% gain in 2017, dumped the stock today because it hasn’t immediately tacked on another 200% in 2018. And it didn’t help that the huge deal that Bristol-Myers struck with Nektar back in February raised expectations to nosebleed levels. Bristol-Myers paid Nektar $1 billion in upfront cash and purchased $850 million on the company’s stock. More than enough to raise hopes–and a few eyebrows.

Let’s start with the results released at the American Society of Clinical Oncology (ASCO) meeting over the weekend. Data from a trial of a second cohort of patients taking a combination of Opdivo,  Bristol Myers immuno-oncology drug, with Nektar 214, turned out to be weaker than results from the first cohort trial. But there’s a good probability that the scores for the second cohort will improve as a cohort “ages,” which is what typically happens with immune-oncology drugs. The market is very, very sensitive about the results of combination trials of immuno-oncology drugs since the April failure of Incyte’s (INCY) Epacadostat in combination with Merck’s (MRK) Keytruda. Those two companies ended the trials on those results, the worst possible outcome from an investor’s perspective.

But while I do recognize that the market is very sensitive to another failure in another combination trial, I would point out that in important ways the results of the Opdivo/NKTR 214 combination trials don’t represent a failure. What the combination therapy needs, if it is to win approval from the U.S. Food & Drug Administration and to gain traction in the marketplace, is a rationale for the use of this drug. And I think the trials showed such a rationale. About 70% of cancer patients don’t have the PD-L1 marker that results in success with Merck’s Keytruda. The Opdivo-NKTR 214 combo showed especially strong results with patients without that genetic marker. 60% of PD-L1 negative patients with melanoma, for example, responded to the Opdivo-NKTR 214 combo. Or to take another example, for urothelial cancer 60% of the PD-L1 negative patients responded to the combination. (In addition the safety data were excellent.) The trials did meet pre-specified efficacy criteria for first line melanoma, first line renal cell carcinoma, and first line urothelial carcinoma.

There are no signs that Bristol-Myers is losing faith in its deal with Nektar as a result of these trials. Bristol-Myers February deal with Nektar was to develop and conduct trials in 20 indications of nine tumor types. Walking away from a clinical program of that magnitude would require a much bigger failure in more than one set of results. And the companies announced that they will begin a Phase III trial in first-line advanced melanoma patients in the third quarter of 2018, and are designing studies in renal cell carcinoma and urothelial cancer. No signs that the companies are about to pull the plug as Incyte and Merck did.

The other issue that I think concerns the market–and that contributed to the huge drop yesterday–is the very small size of these trials. Nektar represented data from just 17 patients in this cohort. That with the market already nervous about combination trials set off worries among some analysts. The next stage of the trials will include 400 patients with melanoma, renal cell, urothelial, non-small-cell lung and triple negative breast cancers, which should to a degree address those worries.

You’ll notice that so far I haven’t made much of Nektar’s filing of NKTR 181, its non-addictive opioid, for approval with the FDA on May 30. The drug is fully owned by Nektar, so the company won’t have to share sales and profits with anyone. The news on Nektar’s lead immune-oncology drug candidate pretty much wiped NKTR 181 out of the market’s mind. It’s an open question on how fast the FDA will move on a new, non-addictive opioid, but given the current opioid crisis I’d be surprised if the agency didn’t meaningfully fast track NKTR 181.

So what do you do now if you own Nektar shares (Nektar is a member of my Jubak Picks Portfolio) or Nektar options (I hold the options in my Volatility Portfolio on my subscription sites JubakAM.com and JugglingWithKnives.com.

If you own the shares, I think the answer is simple. Hold on–at a minimum–or buy some more to take advantage of the market over-reaction. Nektar will gradually claw its way higher. The stock is up $2.39 a share (or 4.53%) as of noon New York time today to $54.98. I see the stock working its way back to $95 a share in early 2019.

For option holders, the issue is time. Markets don’t get over 40% drops, justified or not, overnight.

I’m recommending a sell of the August 17, 2018 call options in the Volatility Portfolio that I bought back on February 25, 2018. (If you want to follow that portfolio, you’ll need to subscribe to either the JubakAm.com or JugglingWithKnives.com sites.) The strike price of $90 is just too far away from today’s $55 and the time until August 17 is just not long enough. Remember there is no “almost” in options. If the stock rallied to $80 by August 17, a great result if you owned the shares, the call options with a strike of $90 would still expire worthless.

Instead I’m using the sell off in the shares–and even the bigger sell off in call options–to buy exposure to Nektar at a lower strike price, with either equal or more time to expiration, and at much lower option price. The August 17 call at $90 dropped 97% yesterday. (And while it’s up 42.86% today that’s from the much lower “crushed” price.)

My recommendation–and I’ll make these moves in my Volatility Portfolio today–would be, first, to buy the August 17, 2018 call options with a strike of $60.  They’ve almost in the money and $60 is certainly within reach by the time the options expire. These calls dropped 83% yesterday and have climbed 18.4% today. At a price of $4.50 or so they’re considerably cheaper than the $16 I paid for the August 17 calls at $90 back in February.

And second, I’d use the big sell off in options to go out to the January 18, 2019 call options with a strike, again of $60. The price of $10.29 this morning is again much cheaper than the $16 I paid for a shorter option (August 17) and a higher strike ($90) back in February.

Not everyone will want to double down on Nektar after yesterday. The day was a huge reminder that this is a volatile stock in a volatile sector. In the Volatility Portfolio I’ll be adding a position in each call option. In your own portfolio you might be more comfortable either picking one call or the other, or splitting your investment between the two options.

Full disclosure: I own Nektar shares and options in my personal portfolios. I haven’t yet made the trades in my portfolio I outline above but will once my three-day waiting period between recommendations and personal buying and selling passes.