New Trade – $XBI: Bio Engineering

by CC September 2, 2015 10:47 am • Commentary

Yesterday (here) we took another look at the Biotech sector. We first posted feelings on Aug 6th, where we made the following observation from a technical and sentiment standpoint:

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:

XBI 1yr chart from Bloomberg

The sector obviously broke the uptrend, and is now down about 20% from the all time highs made in mid July.  $200 is a massive technical level, and whether it holds the 200 day moving average or not (purple line below) will determine the next 10% in the biotech etf. If broader market volatility continues it won;t hold:

XBI 1yr chart from Bloomberg
XBI 1yr chart from Bloomberg

As we highlighted yesterday, options prices are very high making long premium directional trades challenging in the event that the underlying etf settles into a range or worse drifts in the opposite of one’s desired direction:

XBI 1yr chart of 30 day at the money implied vol from Bloomberg
XBI 1yr chart of 30 day at the money implied vol from Bloomberg

So here is the trade:

XBI ($219) Bought Sept 215/190 put spread for 5.50

-Buy to open 1 Sept 215 put for $7.30

-Sell to open 1 Sept 190 put at 1.80

Break-Even on Sept Expiration:

Profit: gains of up to 19.50 below 209.50 with max gain at 190 or below

Loss: of up to 5.50 above 109.50 with max loss at or above 215

Rationale: We sold the downside put to help mitigate potential decay into Labor Day and Chinese markets being closed the next 2 days. If the etf settles or drifts higher we will have to look to cut losses quickly, using a 50% premium stop.