How to Profit From an AI-Driven Biotech That Has Lost Half Its Value in 2024

I'm always on the lookout for stock candidates to bottom fish — where it makes sense and the trade strategies I employ look beneficial.

Schrödinger, Inc. SDGR, a small-cap name that should report third-quarter results shortly, has lost roughly half of its market value this year. Given that tax-loss selling is now ebbing as many mutual and hedge funds' fiscal years just concluded at the end of October, this seems an appropriate time to take a position in this hybrid concern. 

Last year, the Russell 2000 index gained 14% in the fourth quarter as it made up considerable ground against the outperformance in the S&P 500 in the closing stanza of 2023. So far in 2024, the Russell has had only half the returns of its larger brethren, possibly setting up a similar scenario in the last couple of months of the year. In addition, the options around the equity have solid liquidity and good premiums. 

Schrödinger is utilizing AI to improved drug discovery. The premise being enabling AI for drug discovery will result in a higher hit rate and lower overall developmental costs. 

There are two core segments of Schrödinger's business. First, the company has eight wholly owned compounds that it is advancing within its development pipeline. These are all early stage so they are mostly wildcards at this point.

The company also partners with larger clients such as Bristol-Myers Squibb BMY and Gilead Sciences GILD. Schrodinger earns upfront payments, milestone payouts as well as potential royalties on any commercialized sales. There are nearly a dozen and a half candidates on this side of pipeline, inclusing one that is approved and a few others that are in mid-and late-stage development.

Schrodinger also develops and provides software for drug discovery business. The company's primary clients are largely in the life sciences and industrial materials industries. While the revenues from the drug discovery side of the business are lumpy due to the timing of developmental and regulatory milestone payouts, sales from software are much more consistent. Software sales rose 21% on year-over-year basis to $35.4 million in the second quarter.

While Schrödinger is still posting quarterly losses, the company has a healthy balance sheet. The company ended the first half of 2024 with around $380 million of net cash and marketable securities on its balance sheet. And this does not include about $50 million worth of proceeds it would have received when a company it had an equity stake in was acquired by drug giant Eli Lilly LLY. Schrödinger in July.  

SDGR stock currently trades around $18 a share and has a market cap of approximately $1.3 billion. I don’t see SDGR spiking significantly higher, but a decent rebound seems like a decent possibility and the shares should at least find a bottom. Either outcome I can make solidly profitable with the following covered call strategy.

Option Strategy

This is how one can initiate a holding in SDGR with a covered call order. Remember, covered call orders involve buying an equity and simultaneously selling just out of the money call strikes against the new position.

Using the March $17.50 call strikes, fashion a covered call order with a net debit in the $14.75 to $14.85 a share range (net stock price - option premium). 

This strategy provides downside protection of 18% with similar upside potential even if this stock falls slightly over the four-and-a-half-month option duration.

At the time of publication, Jensen was long GILD and SDGR.