The Stansberry folks are predicting another collapse in a stock’s share price, and urging you to get on board with a short position (or, one imagines, a put option). The last time they urged an aggressive short position in their ads was with General Growth Properties, the mall REIT that they predicted would go bankrupt back in December.

GGP didn’t quite go bankrupt, at least, not yet, but they were certainly right about the continuing decline — the shares were at about $1.80 when they predicted imminent bankruptcy, and they’re down about 75% from there (47 cents, last time I checked).

So, this is from a different analyst, and a very different rationale … but perhaps worth a look?

The ad is for the FDA Report, which we’ve seen teased before from Stansberry & Associates — it’s a relatively expensive trading service that aims to profit by predicting results of clinical trials, or at least trading on probabilities around those trials. In the past the expert they trot out for this has been George Huang, so I assume that’s who still does these trading recommendations, but I didn’t see his name in this ad.

So what do they promise?

“On April 30th, a Seattle drug company will announce the results of a prostate cancer vaccine in the final stages of clinical testing…

“If successful… it would be the biggest cancer breakthrough to date….

The medical community is so excited about this event; mainstream news sources are already brimming with anticipation as the date draws near ….

Sounds like a “slam-dunk” situation, right?

“But what if I told you that there’s overwhelming evidence that this vaccine is going to fail on April 30th?

“In fact, what if I told you it’s already failed clinical trials once before – a little-known fact about this “miracle” cure.

“But that’s not all… What if I told you that these clinical trials are so severely flawed, there’s no way patients participating in them will show positive results?

“On top of that, what if I said the FDA has never, ever approved this type of drug before? It other words, this class of drug has a 100% FAILURE rate.

“Look, there’s lots of uncertainty in the markets right now, but I believe—as strongly as I have believed anything in my financial career—that the FDA WILL NOT approve this new vaccine. ”

So that’s the setup — a drug that they tell us is expected by everyone to be a big winner, but their secret analysis has revealed that it will fail. [I’d argue that they’re overstating the market’s positive sentiment about this drug, but that’s neither here nor there.]

And they tell us they’ve got a special way for you to bet against the drug, thereby tripling your money (or more) when the bad results come out in April.

There are several examples given to illustrate their ability to pick these “FDA losers” that will drop in share price — one of them is our old friend Electro-Optical Sciences (MELA), which was teased pretty heavily last year by some other newsletters …

“Several months ago, a company called Electro-Optical Sciences (MELA) began developing a device to better screen for skin cancer. Anticipation of the trial results pushed the stock to almost $10. Again, investors got excited… but our Ph.D. knew the device would never make it past the FDA. Sure enough, he made a quick 60% profit.”

MELA shareholders might dispute the “would never make it past the FDA” bit — it hasn’t yet, and it has been delayed, but many folks still appear to be optimistic (and since this is an external medical device/tool, not a drug, the approval process would usually be expected to be quite a bit less onerous). Undoubtedly, though, the huge ramp up in the share price last year created a nice opportunity for short term gains for short sellers.

And the examples really pile up — they make the point that 80-90% of new drugs fail in the clinical trial process, which is true, and that the industry is built around a “boom or bust” mentality that means companies try to develop as many potential compounds as possible so that one of them might become a blockbuster and pay for the failures of the others.

All certainly valid points, though we should note that most drugs fail pretty early in the approval process, when expectations are often fairly low — if they make it through to Phase III trials the odds of approval are certainly far higher than 10%. (That’s a kind of survivorship bias — sort of like the life expectancy boost you get when you’re older. A boy born in 2004 was expected to live to age 75, but a man who turned 65 in 2004 was expected to live to 82 … once you’ve survived through a lot of things that killed many of your cohort, your odds improve.)

There are several examples given of failed drug trials, and a bunch of charts of collapsing stock prices from biotech companies who saw their meal tickets rejected by the FDA. I think we can stipulate that yes, especially for small companies with relatively small pipelines of new drugs, the share price gets hammered if those drug candidates get rejected. Especially if they’re high profile drugs that have gotten investors excited.

Of course, all the examples are not necessarily gains that their “expert” has made — these are just examples looking back at failed drugs and the impact on a stock, examples that anyone could compile with a little time. The trick is predicting these in advance.

“The point is, it’s a lot easier to make money predicting the drug failures than successes.

“You can easily make a lot of money by betting against the success of these very sophisticated and risky clinical drug trials.

“And these opportunities are everywhere. You just have to know where to find them.

“In fact, if you simply bet against every single one in the stock market, then you’d be right approximately 80% of the time.”

That’s a bit of an exaggeration, of course — there are many failed Phase 1 trials that don’t particularly shake the stock of companies, especially the larger pharmaceutical companies who are responsible for a large number of the drugs in development, and those Phase 1 and 2, relatively lower expectation drugs are certainly part of that 80% number, this is not an easy “drug companies are all destined to fail” calculus. Otherwise, of course, the easy thing to do would just be to short the biotech or the pharmaceutical ETFs.

The claim is also made that the “expert” behind the FDA Report recommendations is well connected, and often knows, to the day, when results will be released for specific drugs. Of course, most people have a very good idea when drug data will be released because companies announce that information, but it’s often not day-specific — more likely it would be something like “by the end of April” as is the case here. If they really had the exact day, and the company had not released the information, either they’re really good guessers or someone’s illegally divulging inside information, which is not particularly likely.

“Most recently, our expert obtained the official announcement date for the company developing the prostate cancer vaccine.

“April 30th… just a few weeks from today.”

So that’s what we’re working with — what are the clues for this specific company?

Three reasons why they say this trial will fail:

“Reason #1 – The clinical trials are severely flawed

“This new cancer treatment is specifically designed for patients in the early stages of prostate cancer. But here’s the thing. FDA regulations don’t allow early-stage cancer patients to even participate in clinical trials because there are BETTER treatments available!”

“Reason #2 – This drug has already failed an FDA trial.

“This new drug already failed a phase III clinical trial, the final step before government approval, in 2005. However, the drug was given another chance by the FDA.”

“Reason # 3 – The FDA has NEVER approved this type of drug before.

“Finally, the FDA, in its 72-year history, has never, ever approved a drug in this class. Considering the clinical trial flaws and past failures, our expert told us “I find it highly unlikely the FDA will approve this vaccine.”

“In fact, we found and FDA publication that backed up this fact: Pub No. FDA 04-1338C

“‘[The drug class] is experimental; none have been licensed by the Food and Drug Administration'”

You could find that FDA publication, too, if you wanted — it’s right here, to save you the search. It’s actually kind of interesting, if you want to get into what a “cancer vaccine” actually is.

So … you could sign up for a subscription to this newsletter if you like (if you do, make sure to review it for us so we know if it’s worthwhile). If you sign up, one of the things they’ll offer you is this ongoing “Crash List” of stocks that they think will fall because of upcoming trials.

But if you just want to know the name of this stock, which is supposed to collapse by April 30, that I can tell you … this is:

Dendreon (DNDN)

Sound familiar? This has been a teaser target before, though on the upside (that was back in 2007, and the stock of course collapsed after that teaser ad, which had promised a breakthrough). The teaser back then was all about the same vaccine, Provenge, which has, as this ad notes, been bounced around by the FDA for years and rejected or sent back to the drawing board before.

And yes, this is really a “cancer vaccine” — though it’s a therapeutic one, not a preventive one. It essentially stirs up the immune system to fight off the cancer, and yes, this trial is being conducted in a population of terminal prostate cancer patients. Prostate cancer is so imminently treatable in most cases that they wouldn’t allow you to give an unproven drug to folks who would otherwise get a great and probably life-extending treatment, whether surgery or radiation or something else, so they have to prove it first in the worst cases, which is one of the reasons Huang and his folks think it will “fail.”

Dendreon is one of the poster children for stock volatility, and Provenge is expected to have more data available by the end of next month — and if you believe the stock will collapse you’re in luck, because they released positive earnings numbers (they lost less than expected) yesterday and the stock is moving up smartly today, so if you think betting against Provenge is the path to riches, you can make your short sale (or buy your puts) at a higher stock price.

Here’s what they announced last night about Provenge:

“‘This is an exciting time for Dendreon as we await the completion of the final analysis of our IMPACT trial, expected by the end of April. The 20 percent reduction in the risk of death that we saw in the PROVENGE arm at our interim analysis is encouraging to us,’ stated Mitchell H. Gold, M.D., president and chief executive officer of Dendreon Corporation. ‘Our mission is to bring PROVENGE to the many prostate cancer patients seeking treatment alternatives that offer a meaningful survival benefit coupled with a more tolerable safety profile than current options, ultimately translating the success of PROVENGE into a platform of products that could benefit patients with many different types of cancer.'”

As for me? I ain’t a clinical trial expert, I’m afraid, so though the odds probably still favor Dendreon continuing to have trouble getting FDA approval because of the novelty of the drug, let me make it very clear that I have absolutely no idea what the results might be, or what impact those results might have on the stock price, which has already come down pretty heavily. And it’s always possible that the results will fail to be definitive, either way, and leave investors confused for a while. This is not an FDA decision that’s coming at the end of April, it’s just the release of the clinical trial results.

This stock has been covered voraciously for quite some time, but if you want a little more background here’s one quick article that gets a bit into the specifics of this trial’s results. If that article is right that the drug has to show a 22% improvement and it’s currently showing a 20% improvement, then perhaps this is really a crap shoot as to whether the performance got slightly better after the initial results were computed.

We should, however, take a moment to think about the mechanics of making these kinds of bets, if that is something you want to do. Dendreon, after a nice bump this morning, is now trading at just a little less than $4 a share — pretty near all time lows, though the stock’s chart looks like a mountain range over the last five years.

There are basically two easy ways to bet against a stock — you can sell it short, or you can buy puts. In this case, if you want to “triple your money … or better” it would probably have to be a short sale, the puts are expensive enough that it would be tough to even double your money.

Selling a stock short means that you borrow the stock from someone else’s margin account (your broker does this for you) and sell the shares at today’s price — to profit from that trade, you then have to buy the shares back at a lower price at some point, so you can return those shares to the lender. In this case, you might sell the shares short at $4 today, and if they do go down to $1.50 on April 30 (just an example), you could buy them back and you’d have a $2.50 per share profit (not counting commissions or margin costs).

Short selling makes it easiest to benefit from a drop in the share price — if the shares fall 50 cents, you make 50 cents a share if you buy them back to “cover” your short position. Easy peasy. But with that relative ease comes theoretically unlimited risk — if this drug does happen to have spectacularly good results, and the shares go up 200% overnight before you have a chance to cover your bet, you might have to cover a huge loss.

A stock has no limit on the upside (on the downside, it can’t go below zero), it could go as high as investors want to drive it, so you can potentially lose really big. Of course, most of the time this probably wouldn’t happen — you would have stops in place, so if the shares went up 30% (or whatever) you’d cover your short bet and be out with that loss. In biotech, however, we should remember that huge moves, both up and down, are not all that uncommon, and if good results or other great news (like a buyout, for example) comes outside of trading hours, there’s always a chance that the stock will move way past your stop point before you’re able to cover.

This is theoretically true of any short sale, of course, and most short sellers are very careful traders who prepare for exigencies, but for super-volatile stocks like Dendreon (and especially, super volatile stocks that are already beaten down and face some news that could be “make or break,” it behooves one to be extra careful).

Buying puts, on the other hand, is a way to shackle your short bet a little bit and know, up front, what the maximum loss is. Buying a put option means you buy the right (but not the obligation) to sell a stock at a predetermined price before the expiration date. Unlike a short sale, where you bank the money from selling the shares (though your broker will hold those in reserve for you against your obligation), for a put option you have to buy it.

If you buy a put option, you can never lose any more than the price you paid for the option — so that’s how you can limit your risk absolutely. Of course, it’s more expensive, and it’s constrained by time. You can short a stock and, if you’ve got enough cash to meet margin calls if the bet goes against you, you can stay short the shares as long as you want if you want to stubbornly hold out for the return you expect. Put options have expiration dates, so you have to be right about timing as well as direction.

Buying puts is a little more of a forgiving process when share prices are relatively high — but of course, when a company is on its last legs, or when investors are very suspicious about their prospects (as is the case with Dendreon, despite the claim that this is a contrarian bet, and was the case with General Growth Properties, for example), then the share price will often have been driven down to the low single digits already, and put premiums will probably be high.

For example, if you want to bet that this late April announcement will be bad, you can buy a May expiration put on Dendreon shares — if you want to buy the right to sell the shares for $2.50 anytime before mid-May, the current price is right around $1.30. That’s a clear sign that there are lots of folks who want to bet against DNDN — if you buy this put option, you need the shares to fall to $1.20 for you to break even (you can sell them for $2.50, but you paid $1.30 for that right). So this is a bet, simplistically speaking, that DNDN will fall by about 60% in the next two months.

Possible, of course, but there’s not a huge margin for profits — and all that needs to happen for you to lose your whole $1.30 investment is for DNDN to stay about $2.50 (to fall by less than 30%).

You can invest more money to get a greater potential return, of course — you can buy “in the money” puts that are exerciseable today — you could, for example, buy the right to sell the shares for $7.50 a share. That option, also for May, would cost you $5.50. So you still need the shares to drop below $2 a share for you to make a profit, but if the shares just linger around $4 or so you might only lose half of your investment (ie, if the shares are at $4 and you can sell them at $7.50, you can cash out for about $3.50, thereby getting some of your initial $5.50 purchase price back).

Of course, if the absolute opposite happens, and the stock shoots to $20 overnight, you can only ever lose what you put in ($1.30 for that first option example, $5.50 for the second). If you had sold the shares short and couldn’t cover in time, you’d owe somebody $20 and would have only $4 set aside to pay them back (the $4 being the initial cash you got for selling the shares short).

Phew … sorry of that was too elementary for many of you, or too confusing for others — I just wanted to provide some actual examples to clarify for those who haven’t done short selling before. Remember, I’m not telling you to do this, just trying to explain what it seems the S&A FDA Report folks are touting.

If you’ve got any thoughts about Dendreon, or betting against clinical trials, or whatever else, feel free to share with a comment below.