MorningWord 1/12/17: XBI, XLV – The War On Drugs

by Dan January 12, 2017 10:01 am • FREE ACCESS

Yesterday, the “Tape-Bomb” in Chief caused a kerfuffle in pharma/biotech stocks after saying that drug companies are “getting away with murder” on pricing. Few, beside drug co execs, lobbyists and major shareholders would disagree with the President-elect’s point.  But in what is becoming a trend, when he sets his sights on an industry or a company, it is not going to be public shareholder friendly nearterm. And that’s what we saw yesterday. Biotech stocks were hardest hit during the 11am hour press conference, with the XBI (S&P Biotech etf) dropping 3.5% in a straight line and closing that way:

XBI 1day chart from Bloomberg

Big Pharma stocks fared a bit better on a relative basis, with the S&P Healthcare Select etf (XLV) only dropping 2% during the presser before recovering a bit to close down on the day 1%.

Despite the sharp one day declines, both etf’s have made up a ton of ground since the election, repairing what had been a fairly hellish political season in 2015/16, with the XBI having a peak to trough decline of 50% from its July 2015 highs to its March 2016 low, now 40% from those lows. To my eye, the XBI has staunch technical resistance at $70, and ok-ish support at $60, with very solid support at the uptrend from the 2016 lows in the mid $50s:

XBI 2yr chart from Bloomberg

As we head into earnings season, and a political honeymoon period with the new congress I suspect it makes sense in sectors like biotech pharma, that already have a sort of bi-partisan target on its back, to define risk if already long the space, or for those looking to be contrarian bullish.

Short dated options prices in the XBI are down considerably from the pre-election levels when it looked like there might be a Democratic White House and Senate and renewed focus on drug pricing. But as yesterday’s price action and rhetoric shows, the Republican sweep, despite lobbyists best efforts, might not bring much relief for the sector as drug pricing criticism seems to be somewhat bi-partisan amongst voters. 30 day at the money implied vol at 33% down from its 52 week highs of 47.5% in Nov:

Bloomberg

So you know the whole first 100 days thingy for new Presidents. And if you were looking to have a little placeholder in biotech stocks during that period, being a bit contrarian but with defined risk, it might make sense to consider call spreads with options prices where they are. For instance with the XBI at $63, the March 63 / 70 call spread is offered at about $2.25, offering a break-even at $65.25, with potential gains of up to $4.75 between $65.25 and $70, with max gain above, more than a 2 to 1 payout.  And the lower the etf goes near term, with a potential tickup in options prices the more attractive arisk reversal might become (selling puts to buy calls or call spreads).