Biotechnology stocks have had their challenges this year. The slide started last year and has been exacerbated by the political rhetoric against biotech. Thus, I want to short the industry using the iShares Nasdaq Biotechnology Index ETF (IBB), which is down 25% for the year-to-date, vastly underperforming the S&P 500.
Click to Enlarge The IBB is $150 per share off its highs. Technically, it now needs a bounce, or the ETF risks inviting heavier selling.
Losing the $240 per share level could put the $200 in jeopardy. The IBB lost several support zones already and is currently hovering just above another.
Fundamentally, biotech stocks have value, so a major selloff should eventually bring out buyers. But for now, the stream of buyouts and mergers is drying out. Trader willingness to buy every IBB dip is consequently waning. Eventually, buyers will step in as prices approach intrinsic values.
The selloff from the highs was a self inflicted situation; prices ran too high too fast and created a situation where we have too many weak hands. Those are traders who will hit the sell button first, then ask questions later.
The trade on IBB that I want is made up of two parts — the main trade, then another move to lower my out-of-pocket expense.
A Two-Part Trade on the IBB ETF
Part 1: Buy the Jun $230 put. This is a bearish trade for which I pay $3 per contract, which is my maximum potential loss. I profit from this trade if IBB price falls past my strike price by mid June.
Part Two: Sell Jan $165 put. This is a bullish trade but at a much lower price point. For this, I collect $3.60 per contract. This adds risk between now and January, but it allows me to collect premium that offsets the entry costs in the first trade.
Ideally, I need the IBB ETF to fall through June but then rebound above 165 by January. I can close either trade at any point to eliminate the risk. If the IBB rallies from here or does nothing at all, I still would end up with a 60-cent-per-contract credit in my account.
A Couple Parting Thoughts
Selling puts is risky, and I do it if (and only if) I am willing to own the IBB ETF at $165 per share. I also make sure that the trade fits well within my portfolio. I am currently more short than long. And in this headline-driven market, I want to avoid adding upside risk.
This pair trade allows me to short IBB without out-of-pocket expense or sold calls.
Nicolas Chahine is the managing director of SellSpreads.com. As of this writing, he did not hold a position in any of the aforementioned securities.