It’s fairly indisputable, there is a sort of rolling sell-off going on in prior bull market leaders. All you need to do is look at the recent 15% declines in stocks like Apple (AAPL) and Disney (DIS) in the last couple weeks/days respectively, the severe weakness in crowded hedge fund names like SunEdison (SUNE), which is down 44% since July 20th when the stock made a new 52 week high. And the list goes on. Semiconductor stocks were huge winners in 2014 and one of the worst groups in 2015, Consumer staples performed admirably last year due to their defensive nature/yield and stocks like Procter & Gamble (PG) are down 20% from 52 week highs made in December. You get the point.
The M&A frenzy in Biotech is unnatural and frankly demonstrates toppy behavior. The XBI, the S&P Biotech etf up 37% on the year, up 75% from its 52 week lows, and only down 9% from the 52 week and all time highs made last month. It looks and feels like an epic short opportunity:
Obviously calling a top in a speculative sector like this can and has been a fools errand, but the behavior in the market as it relates to past winners has changed, and the broad market has clearly stalled its bull market gains, made evident by the tight 5% range the SPX has traded in since February.
I will obviously express this contrarian view by defining my risk, and risk what I am willing to lose.
Options prices for an etf like the XBI made up of lots of mid and small cap stocks is fairly reasonable with 30 day at the money implied vol at 34.5%, pretty much the mid point of the 12 month range:
So here is the problem the XBI has dropped $5 as I was writing and when the etf was just below $250 I was going to do the following trade, I don’t want to press this with the etf down 4.25% on the day (the ETF dropped 5 dollars while I wrote this). SO I AM GOING TO WAIT FOR A BOUNCE, BUT THIS IS WHAT I WAS GOING TO DO:
Hypothetical Trade: XBI ($248) Buy the August 245 puts for 6.00
Break-evens on August expiration:
Profits: like short stock below 239.
Losses: up to 6 above 239 with total loss of 6 above 245
Rationale – If these stocks break they will likely do it soon and quickly. We like the idea of positioning for the break with the option of then spreading the naked put on a continuation of the move. If the stocks do bounce from here we’d try to keep a stop on the put at 50% of the premium paid.
WE WILL FOLLOW UP ON A BOUNCE and will try to be patient.