Trade the Biotech News With Options

by Tyler Craig | November 13, 2012 8:07 am

One of the top performing subsectors during Monday’s seesaw session was biotech. The iShares Nasdaq Biotech Index Fund (NASDAQ:IBB[1]) finished the day up 1.76% on the heels of positive news from two of its top holdings: Gilead Sciences (NASDAQ:GILD[2]) and Celgene (NASDAQ:CELG[3]). The news-driven biotech space is perfect for options — let’s take a look at the sector and pick out a couple of plays.

GILD soared to all-time highs after the biopharmaceutical company released positive results in a mid-stage hepatitis C study. CELG also joined the bullish festivities by gapping up 9% in response to news that their pancreatic cancer treatment drug Abraxene improved survival rates in a late-stage study. While GILD stayed afloat following the initial gap higher and even rallied into the close, CELG experienced a classic “sell the news” reaction by falling notably from its opening gap.

Most investors are a bit gun-shy when it comes to playing in the biotech space — and justifiably so. The industry is a lottery of sorts that inevitably produces a few big winners, but a whole host of losers. Positive results from drug trials can generate “insta-profits” for lucky shareholders while negative results can quickly cut stock prices in half.

And yet, dabbling in biotech stocks doesn’t have to be a mere roll of the dice. Those unwilling to try their hand at picking winners and losers can play the entire industry via exchange-traded funds. By far the most liquid biotech-based ETF is the aforementioned IBB. In recent weeks it has averaged over 600K shares traded per day.

So does the recent spate of positive news indicate it’s time to buy biotech stocks? And are there any options plays that looks juicy after yesterday’s pop? Let’s look to the chart to see if technical analysis gives us any clues.

IBB chart
Click to Enlarge

The ongoing broad-market weakness has seeped into a broad swath of sectors, and biotech is no exception. IBB dropped 7.5% in October, generating its worst monthly performance for 2012. With the biotech fund currently in a short-term downtrend with a declining 20-day moving average, it appears it has some work to do before the bulls pile back in. Monday’s pop did little to change the outlook for the overall sector; the recent strength could be nothing more than a minor bounce within the downtrend.

On the other hand, the IBB chart does reveal two bullish developments. First, the stock was able to bounce convincingly off its rising 200-day moving average. On Friday the bulls came out in force, creating a bullish engulfing candle right at a potential support level. Second, the past two up days have boasted higher-than-average volume, which indicates institutional accumulation.

Recent technical developments are putting out mixed messages — so let’s take a look at two trade ideas, one bullish and one bearish.

The Bullish Play

If you believe Friday’s pivot off the 200-day moving average is an intermediate low that’s unlikely to be breached in the coming weeks, consider selling a December 124-119 bull put spread for $0.65 credit. The max reward is limited to the initial $0.65 credit while the max risk is limited to $4.35 (the $5 difference between the two strikes, less the $0.65 credit).

The Bearish Play

Traders who believe the recent rise in IBB is nothing more than a countertrend bounce with a high probability for failure might consider selling a December 140-145 bear call spread for $0.65. Similar to the spread above, the max reward is limited to the initial $0.65 credit while the max risk is limited to $4.35.

At the time of this writing Tyler Craig had no positions on any of the aforementioned securities. 

  1. IBB:
  2. GILD:
  3. CELG:

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