For week’s now my co-panelist on CNBC’s Options Action, Carter Worth of Cornerstone Macro Research has been making the bullish case for the Biotech stocks, specifically looking at the IBB, the iShares Nasdaq Biotech etf. Watch from Friday’s show:
Carter’s thesis has been right from a technical perspective for the last month,but as I said in the segment I’d be a lot less optimistic if the IBB were able to re-test the downtrend, and then ran out of steam. The main reason for the thought that IBB could be a great short at the downtrend (which would make Carter’s bullish call correct by the way) is that it has massively under-performed the broad market from its highs last year’s highs (down almost 30%) and its only moderate out-performance from its early February lows of 19% (SPX is up 15%). Given the current rate political environment regarding drug pricing and the regulatory environment regarding M&A, I suspect biotech stocks continue to under-perform in this election year. For the most part the largest components of the IBB are mega-cap biotechs that resemble big Pharma (GILD, AMGN, CELG, BIIB & REGN make up 40% of the etf’s weight, equaling about $500 billion in market cap).
Which leads me to the XLV, the Health Care Select etf, whose top 5 components (JNJ, PFE, MRK, GILD & UNH) make up about 35% of its weight, and saw a decent size bullish roll today. When the XLV was $71.50 a trader sold to close 20,000 Sept 72 calls at $2.50 and bought to open 20,000 Sept 74 calls for $1.60. These calls break-even at $75.60, up 7% from the trading level on September expiration, back above its breakdown level from mid August.
The one year chart below shows the recent pop above technical resistance at $70, and more importantly the downtrend that has been in place since its 52 week highs in late July:
A pull -back towards the down-trend, very near $70 could be viewed as a decent long entry, if it holds, if you agree with Carter’s bullish view on biotech, but I might lean to a more defensive mix of stocks like the IBB which includes big Pharma stocks like PFE & MRK with dividend yields nearly 2x the 10 year treasury yield.
BUT a failure here and a break below support at $70 would signal the index is clearly in a downtrend, confirming a new lower high, on its way to a lower low.
Short dated options prices, very near 9 month lows, offer directional players attractive ways to define their risk in the XLV… 30 day at the money implied volatility (the price of options, blue below) are essentially in line with 30 day realized volatility (how much the etf has been moving, white below), options appear cheap: