(IBB) Biotech Breakthrough

by Dan January 23, 2018 3:20 pm • Trade Ideas

Biotech stocks have gotten off to a good start in 2018, with a couple of big m&a deals fueling the enthusiasm. The relatively equal-weighted S&P Biotech etf, the XBI is up nearly 11% ytd, just yesterday making a new 52 week high, and following through today:

XBI 5yr chart from Bloomberg

Interestingly, the Ishares Nasdaq Biotech etf, the IBB, which is heavily weighted towards large-cap stocks, with the four largest holdings; Amgen, Gilead, Biogen and Celgene making up a third of the weight of the etf. The IBB has underperformed the XBI, as the XBI is likely getting a boost from small to midcaps that are perceived to be takeout candidates. Like the XBI, the IBB this week made new 52 week highs, but unlike the XBI, the IBB is still a ways away from its all-time highs that were achieved in mid-2015, and remains 10% below those levels:

IBB 5yr chart from Bloomberg

To my eye, this is one of the most constructive sector charts in the market, especially when you consider the smaller cap more equal weight XBI confirming the daily new highs in the broad market, possibly setting up for large-cap biotech to play catch up in the near future.

Short-dated options prices are fairly reasonable in the IBB with 30 day at the money implied volatility at 18%, just a couple points off of five-year lows, possibly making long premium directional options trades attractive:

Bloomberg

Most of the large holdings in the IBB report Q4 earnings between now and Feb expiration. If you thought that earnings could be the catalyst to send the IBB back to the prior all time highs, then Feb call spreads make sense.

So what’s the trade?

Trade Idea: IBB ($116.85) Buy Feb 117 / 124 call spread for $2

-Buy 1 Feb 117 call for 2.35

-Sell 1 Feb 124 call at 35 cents

Break-even on Feb expiration:

Profits of up to 5 between 119 and 124 with max gain of 5 above 124

Losses of up to 2 between 117 and 119 with max loss of 2 below 117

Rationale: this trade risks a little more than 1% of the etf price for a break-even up less than 2% of the etf price. The most that can be lost is 2.00 so the potential reward of 5.00 at or above 124 is decent risk reward. The cost of defining the risk is the higher breakeven of 119 (vs the current stock price just below 117)