The Biotech sector has been a massive out-performer over the last year, with the IBB (iShares Nasdaq Biotech etf) up 13% in 2015, and up 65% since from the 52 week lows made in April of last year. The IBB is heavily weighted to mega cap Biotech stocks, with BIIB, CELG, GILD, REGN and AMGN making up about 40% of the etf’s weight, representing nearly $500 billion in market cap. There is little doubt that much of the excitement in the Biotech space has to do with what feels like an merger and acquisition frenzy, which in my mind feels fairly bubbly. Just last week Pharmacyclics (PCYC) was purchased by Abbvie (ABBV) for $21 billion, a company that is expected to have a little more than $1 billion in sales. What’s interesting is that Johnson & Johnson (JNJ) has a 50% stake in PCYC’s primary drug Imbruvica, and I think it is safe to assume that they balked on a fairly insane takeover price, which allowed ABBV to step in. You get the point, things feel a tad frothy.
The Biotech space has been on my radar as I have been looking for a short entry on what has been a one way trade higher. If the little sell off that the broad market is currently in turns into something more, I suspect that few sectors will be spared, and that sectors like Biotech that has a good bit of m&a froth in it could get hit hard.
Just a bit ago when the IBB was $343, I noticed an opening buyer of 3100 April 320 puts for $4.40, breaking even at 315.60 on the downside, down about 8% from current levels. What struck me is how cheap options prices looked given the recent uptick in volatility across most other equity sectors and risk assets in general:
Looking at a one year chart of the IBB it becomes apparent that the recent rally has been a slow grind:[caption id="attachment_51825" align="aligncenter" width="600"] IBB 1yr chart from Bloomberg[/caption]
Whats also interesting about the choice of strikes of the trade detailed above is that $320 appears to be an interim technical support level, with $300 obvious support.
TRADE – IBB ($342) Bought the April 325/300 put spread for 3.70
– Bought to open the April 325 put for 5.40
– Sold to open 1 April 300 put at 1.70
Break-Even on April Expiration:
Profits: between 321.30 and 300, max gain of 21.30 below 300
Losses: between 321.30 and 325 lose up to 3.70 with max loss of 3.70 above 325
Rationale – This is an out of the money put spread that is cheap from bot an implied volatility perspective and dollar cheap itself. A pullback in these stocks likely means a a move back towards $320 in this etf. A break bwlo that and there’s lots of room to the next meaningful support.