06/24/2014

Positive Results for Vertex Pharmaceutical; Ok Results for Structured Note Holders

This morning Vertex Pharmaceutical (VRTX) announced positive results for phase 3 clinical trials.  As a result, the stock soared 50%+ pre-market, surpassing $100 for the first time in the firm’s history.  Of course, an unsuccessful outcome would have resulted in an extraordinary move in the opposite direction; clinical trial outcomes such as these present extreme binary events to investors.

In late February, 2014, a structured note was issued with roughly $20 Million in notional on VRTX.  As I wrote in my blog post on binary events, this structured note presented investors with two unattractive outcomes – if the VRTX clinical trial was successful, the stock would appreciate significantly and the structured note would be called early and investor returns would be capped at a modest 5.5% yield (about 11% annualized).  If the trial was unsuccessful, the stock would take a substantial hit, perhaps substantial enough to eliminate any principal protection and thus expose investors to a major loss.

Since VRTX is now well above the issuance price of $84.81, the note is due to be called August 21 provided the stock does not pullback below the issuance level.  Investors will receive their principal back at that time, resulting in a grand 5.5% total return over 6 months.  In contrast, as of this morning’s opening, VRTX was up 15.6% as compared to the price when the structured note was launched; thus, investors who owned VRTX outright will finish considerably ahead of owners of the structured note.

In conclusion, the structured note I analyzed offered a tantalizing annualized yield, but exposed investors to a major potential loss with limited upside.  If investors plan to pursue investing in binary events, they might want to consider solutions which better balance the risk-reward tradeoff.

One thought on “Positive Results for Vertex Pharmaceutical; Ok Results for Structured Note Holders

  1. I’m certain how this one was marketed…

    Here is an opportunity to pick-up a solid, 11% annualized cash flow. Even if the stock goes south, you’ll still get the coupon. And don’t worry too much about losing principal, because there is an extremely generous buffer of 45%. That’s right: the stock would have to lose almost half it’s value for you to be exposed to loss. You’ll still get the coupon regardless, which in the extreme unlikelihood of a 45% or greater decline will help offset your losses. The common shareholders will have no such benefit.

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