Bear Down on Biotech Stocks Now (IBB)

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Biotech stocks have recently fallen out of favor, though they’re still outperforming the major indices for the year-to-date. For example, the iShares Nasdaq Biotechnology Index ETF (IBB) — a popular biotech ETF — is up 9% year-to-date vs. roughly flat performances for the Dow Jones Industrial Average and S&P 500.

And even then, the IBB is off $70 from the year’s high of $400 per share!

Fundamentally, biotech stocks have a good fan base; investors are eager to buy most dips in the IBB. More importantly, there is ongoing widespread industry consolidation and financial engineering. Bidding wars and generous buyback programs account for a significant portion of the gains in IBB stock price.

Technically, the IBB price bounced sharply off the $300 level twice in 2015, but it also has set lower highs. The result has been a tightening of the fund’s price range. This is a buildup of energy that will need to resolve itself with a sizable move. (The direction of said move is not yet clear.)

IBB chart
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The IBB lost a two-year long support trend line in August 2015, and it has since failed to recapture it. This prior support is now proving to be resistance.

Heading into a price range squeeze with resistance above, I favor a break in price to the downside.

The trade I want is made up of two parts. Options are time-sensitive, so I want to give myself time to be right. An easy way to profit from a down-move in biotech stocks is to buy puts in the IBB.

A Two-Part Trade on the IBB

Part One: I buy the Jan 2016 $300/$295 debit put spread. To buy it, I pay 70 cents per contract, which is my maximum potential loss. Ideally, if in the next 38 days the IBB stock price falls past $295 per share, I gain up to $4.30 per contract.

The components of the IBB are volatile biotech stocks, so I want to reduce my out-of-pocket risk. I can accomplish this by selling IBB calls and collect premium that would offset the entry costs into the debit put spread.

Part Two: I sell the Jun 2016 $420 call and collect $3 per contract. This adds risk for losses if IBB  rallies higher than $420 in the next 192 days. I can close either trades at any point to eliminate the risk. Ideally, I want the IBB price range squeeze to resolve itself to the downside so I can profit from my debit put spreads that I bought at a discount.

A Couple Parting Thoughts

It is important to note that recently, drug prices have become a political item of discussion. Politicians have vilified some drug companies for price gouging. These debates tend to be negative in nature and will likely linger through the coming year.

The U.S. Fed rate decision will also play an important factor that necessitate me to manage the trade in the next couple of weeks.

As of this writing, Nicolas Chahine did not hold a position in any of the aforementioned securities.

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Nicolas Chahine is the managing director of SellSpreads.com.


Article printed from InvestorPlace Media, https://investorplace.com/2015/12/bear-down-on-biotech-stocks-now-ibb/.

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