Biotech stocks have been a disaster so far in 2016, with Nasdaq Biotech etf IBB down 20% ytd, and down 34% from its all time highs (in August 2015), and S&P Biotech etf XBI down 15% ytd and down 34% from its all time highs made in July 2015.
For the better part of 2016, the IBB has traded in a very well defined range between $240 on the downside and $300 on the upside:
The price action in the XBI is a bit more constructive up about 36% from its 52 week lows made in February, vs the IBB up only 12% since its Feb lows. Most importantly, despite having sold off $10 in the last month, XBI remains in a well defined uptrend from its 52 week lows:
The sector is clearly spooked by the increasingly likely prospect of Hillary Clinton winning the Presidency, the Democrats winning back the Senate and even the outside chance of taking back the House (the House is unlikely but possible). The sector is pricing in a lot of bad news already given the bi-partisan focus on drug pricing and the potential for increased regulation, especially under a Democratic White House and Senate. But I will say this, while Secretary Clinton has talked (and tweeted) tough on drug pricing, she is NOT Elizabeth Warren. I can see a scenario where drug stocks rally no matter what the outcome is in November once it’s clear regulation will be relatively minor.
Short dated options prices reflect investor unease, with 30 day at the money implied volatility in the XBI at 39% (blue below, the price of options), despite 30 day realized volatility (white below, how much the etf has been moving) at 30%, very near the lows of 2016:
If I were inclined to play for a bounce in Biotech stocks I might look to express this view in the XBI for a couple of reasons. First the relative out-performance to the IBB, and the more evenly waited nature of the etf, with no one stock making up more than 5%, with most weighted between 2 and 3%.
Options prices are high, and after the election I suspect they abate a bit. To put the implied movement between now and Jan expiration in the XBI in some context, with the etf just below $60, the Jan17 60 straddle (the call premium + the put premium) is offered at $9, if you bought that and thus the implied movement in the XBI, you would need a move above $69, or below $51 to make money, or about 15% in either direction. For more context, the etf that tracks the S&P 500, the SPY, at $214, its Jan17 214 straddle is offered at $11, or about 5% of its underlying price, 3x that of the XBI!
If I were inclined to play for a bounce back to the recent highs in the XBI, I would look past the election, and into the new year, actually to the Presidential Inauguration on January 20th.
Trade: XBI ($59.85) Buy Jan 60 / 75 call spread for $4
-Buy 1 Jan17 60 call for $4.40
-Sell 1 Jan17 75 call at 40 cents
Break-Even on Jan17 expiration:
Profits of up to $11 between $64 and $75, max gain above $75
Losses of up to $4 between $60 and $64, with max loss of $4 below $60, or 6.5% of the etf price.
Rationale: The etf is priced for movement, I suspect we get some, and maybe it continues to be weak into the election, but I think there is a far better chance that the next $10 are higher than lower given how poor sentiment is, and current investor positioning.
OR
While Straight call spreads are easier to trade and to understand risk reward, we also like call butterflies, to offset the potential hit to options prices after the election, and minimize premium at risk.
Trade: XBI ($59.85) Buy Jan 60 / 70 / 80 call butterfly for $2.50
-Buy 1 Jan17 60 call for $4.40
-Sell 2 Jan17 70 call at $1 each or $2 total
-Buy 1 Jan17 80 call for 10 cents
Break-Even on Jan17 expiration:
Profits of up to $7.50 between $62.50 and $77.50 with max gain of $7.50 at $70
Losses of up to $2.50 between $60 and $62.50 & between $77.50 and $80, with max loss of $2.50 below $60, or above $80
Rationale: We would probably lean towards the Call Butterfly as the trade could be fairly binary and we think it makes sense to limit the premium at risk given the high levels of implied volatility and the uncertainty about the sector and its reaction to the election.