I question whether Black-Scholes is a good model for valuing options in development stage biotech. The formula depends on the assumption that options can be replicated with dynamic hedging, which in turn assumes that the stock price is continuous. For example, as the stock price goes up from a point where the delta is .5, you replicate the option by buying additional shares so that the number owned takes into account the increasing delta (ultimately, the delta of a deep-in-the-money call approaches one). Dendreon is a particularly good example of a stock about to face a discontinuous stock price, at least, if you believe that sometime on or before May 15, a binary event will happen. Admittedly, CEGE is less binary than that.
It is something of a mystery to me what the DNDN stock price, in combination with the option pricing, tells us about the post approval stock price and chance of approval. It cannot be telling us that there is a large chance of failure or that the stock is likely to skyrocket if there is approval. For example, you could explain a stock price of $15 by saying that the market believes there is a 50% chance of success (to be followed by a $28 stock price) and a 50% chance of failure (to be followed by a $2 stock price). The mathematical expectation of those two outcomes is $15. But then the call would be worth .5 x (28 - 15) = $6.5, and the put would be equally valuable. But instead, the 15 put and call are trading for about $3.8. I think this all suggests that the market is assigning a relatively high probability to approval, and that as the approval is expected, a large price jump is not. expected. I am not saying I agree with that assessment, but it seems to me that is what the stock and option prices imply.
AI
