Name That Trade – $XBI: Bio-Dome 2

by CC September 1, 2015 12:07 pm • Commentary

A few weeks ago, when the M&A frenzy in Biotech was demonstrating toppy behavior we posted a Name That Trade in the S&P biotech etf XBI. At the time it was up 37% on the year, and 75% from its 52 week lows. We said a lot of things in the post but this summed up our main thoughts:

It looks and feels like an epic short opportunity

XBI was $248 at the time and quickly cratered. We liked the idea of puts outright and thought the best looking one was in August:

Hypothetical Trade: XBI ($248) Buy the August 245 puts for 6.00

XBI went below 200 in the panic selling but has bounced back to its 200 day moving average around $220. But a failure here amid broader market pressure brings a ton of risk to the downside:

Screen Shot 2015-09-01 at 9.45.09 AM
2 yr XBI from LiveVol Pro

The panic “low” of 180 is not out of the question and certainly the area just north of 200 seems realistic. The bounce back level of 230 seems like an obvious entry on the short side with your risk there likely only to 240. But at 220 things are a fuzzier and it becomes a bit more of a market call.

Implied volatility also keeps the trade from being a no brainer here. The etf normally sees implied vol in the low 30’s but October vol right now is about 43, although that’s down a lot from last week:

[caption id="attachment_56530" align="aligncenter" width="745"]Screen Shot 2015-09-01 at 9.53.55 AM 1 yr IV30/HV30/HV360 from LiveVol Pro[/caption]

Taking advantage of the high implied vols on a directional basis to the downside is difficult because any sharp move lower will cause vols to spike back up towards last weeks highs. Therefore this is more of a trade about timing of entry. If we say a move back towards that 230 entry point we’d likely look for a very wide put spread targeting a retest of the 200 level with the hopes of another break below that. Right now the October 220/180 put spread is about 11 dollars. If we say that in single digits it could set up as a great risk reward for a move back towards the recent lows. If we saw that ideal entry up near 230 we may even consider an outright put purchase like the Oct 225s or 220s.

So for now this is still hypothetical until we see a better entry or the selloff in equities becomes a no brainer. Stay tuned as we’ll have to make a quick call when we decide to pull the trigger.