Some Actionable Option Strategies In Biotech — Bret Jensen
I got a question from a subscriber on the Biotech Forum yesterday about what option strategies I use to manage my own portfolio. This is not part of the Biotech Forum service whose portfolio consists of my top five large cap growth plays within the sector which are heavily weighted paired with 15 much smaller holdings in the more speculative small cap sector portion of this lucrative but volatile sector. However, it was an interesting inquiry as I do use option strategies trading within my own portfolio dedicated to biotech.
I am particularly fond of using just out of the money bull put spreads on my large cap growth positions within the space whenever we get a hiccup in the sector like we have over the past few months. This strategy consists of selling one put option just under the current price of a stock like Celgene (NASDAQ:CELG) coupled with buying a more out of the money put option and pocketing the spread. I have found this is a good way to either pick up premium or get lower entry points on stocks you already want to add shares to your established core holding. I like this strategy better than just selling out of the money puts as it requires less collateral from your broker and provides some near-term downside protection should the market completely fall apart.
I also like to use out of the money bull call spreads when I feel a stock or sector is at an inflection point. This consists of buying a near-term out of the money call option and selling a further out of the money call option and paying the spread. I like this strategy as when you are right you make a killing and when you are wrong, you lose just the spread you pay. Obviously you do not to be right too often to make this strategy a winner over the long term if consistently deployed correctly. It also avoids the situation where you buy the stock or index outright and that “inflection point” turns out to be a “falling knife” in reality.
Yesterday an opportunity came about to place a trade using this strategy on the largest biotech ETF, the iShares Nasdaq Biotechnology ETF (NASDAQ:IBB). The biotech sector has been under pressure since early August and is now officially in bear market territory. Yesterday the index fell another three percent as the election-driven rhetoric around drug price “gouging” escalated.
(click to enlarge)
However, there are factors I believe point to a sector that is at an inflection point. First, the index does seem to be trying to find a bottom around the $300 level. In addition, declines in the biotech sector tend to be quick and deep. The last one we had occurred in early March of 2014 and lasted approximately two months. I think we are getting overdue here for at least a significant relief rally.
Most importantly, we start to get quarterly results from the heavyweights in the sector like Gilead Sciences (NASDAQ:GILD) and Amgen (NASDAQ:AMGN) next week. I do not think it is a coincidence that the major part of this recent pull back did not occur until after these reports came in for the second quarter, which largely beat expectations; hit the market and there then was a dearth of good news to offset the change of sentiment on the sector that has happened since these last time these biotech juggernauts reported.
My thesis is once these earnings reports start to come in there is a potential for a large reversal in the sector. I purchased 10 bull call spreads on the IBB late in trading yesterday. Specifically, I bought the November $330/$360 bull call spreads, paying $3.60 for each contract. This means I purchased the November $330 calls that expire November 20th while selling November $360 calls that expire the same day.
If we get a huge counter rally after earnings my upside is potentially up to $26.40 on my $3.60 bet. In reality, if the spread hits $7.20 I will sell half my position to be in the position to ride solely on the “house’s money”. I offer this option idea up this morning in pre-market as food for thought. One must have the ability to institute this trade at their broker which usually involves filling out a form. Although not for everyone, option strategies are a good thing to have in an active traders’ “toolbox”. I strongly encourage anyone that wants to learn how to learn options to read up on the subject as there are many good books on the subject on Amazon and the strategies are relatively easy to learn and employ.
NOTE: For more traditional biotech investors that want my free report on three of the most attractive Large Cap Growth plays in biotech, just go to shotguninvesting.com and register. These are three of my core picks within my own portfolio and ones I plan to hold for 3–5 years. These stocks are more appropriate for the vast majority of retail investors than the option strategies described above.
Thank You & Happy Hunting
Editor, Biotech Forum
Disclosure: I am/we are long AMGN, CELG, GILD, IBB.
Originally published at seekingalpha.com.