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Last Monday, the Basel, Switzerland based drug giant Roche Holding Ltd. (RHHBY.PK) 90.75 made an unsolicited and unexpected offer to purchase the remaining 44% of Genentech (DNA) 96.00 that it does not already own. Since then the stock has risen above the offer price of 89 on the expectation that it will require a higher price if they are going to succeed.

Roche has drawn attention to the recent actions of the Europeans who are taking advantage of depressed stock and currency values in the US to make strategic long-term acquisitions at bargain basement prices. With its action, Roche has also drawn attention to recent rising prices in the biotech sector. In IVolatility Trading Digest™ Volume 8, Issue 23, Momentum Waves, dated April 14, 2008 we wrote about the waves of investment capital flowing from sector to sector. It now appears the momentum wave is flowing from oil, gas and energy into other sectors, including biotech.

In this issue we are going to take a look at the biotech sector ETFs and then make suggestions for some specific stocks.

Market Review

Since there were few noteworthy developments last week in the Market Review sections we are going to use the space to offer more option suggestions in the biotech sector. We will return and with an update and the Market Review again next week.

Strategy

Consistent with the flowing momentum waves the strategy is to identify the sectors that are trending higher for long positions and the ones that have broken uptrends for the shorts. With perhaps a few exceptions we think the financials are still in the short group along with oil and natural gas. In the meanwhile biotech remains in a well-defined uptrend from the March 17, 2008 lows.

Biotech

Biotech also called biopharmaceuticals is a group consisting of both large established companies with substantial product and development pipelines to small research and development joint-venture companies with a single product or development effort. We often see these biotech companies in our high-implied volatility screens before the announcement of FDA test results. Since it is extremely difficult to make fundamental judgments about the likelihood of success for a particular new drug trial we do not attempt it and we usually exclude these issues from consideration. For those of us without the biotech industry knowledge and background the alternative is to use ETFs that include most of the companies in the sector.

Biotech ETFs

Here is a selected list ETFs for this sector.

Biotech HOLDRs (BBH) 196.99
iShares Nasdaq Biotechnology (IBB) 85.91
SPDR S&P Biotech (XBI) 65.07
PowerShares Dynamic Biotech & Genome (PBE) 18.95
First Trust AMEX Biotechnology Index (FBT) 25.52

When we ran the ETF symbols through our Advanced Options and Advanced Historical Data sections we discovered there are only two, BBH and IBB that have meaningful options volume and open interest. Of the two only IBB has enough trading activity to be considered.

From the lows on March 17, 2008 the sector traded mostly sideways through the end of June before turning higher and creating a defined uptrend that has now been accelerating for the last few weeks. We think it is likely that capital will continue rotating out of oil and gas and into biotech.

Here is an ETF suggestion for the continuation of this defined trend.

iShares Nasdaq Biotechnology (IBB) 85.91

With a current Historical Volatility (HV) of 19.84 take a look at this bull call spread.

• Buy IBB Dec 90 call IBBLR 3.20 IV 20.62 Delta .4192
• Sell IBB Dec 95 call IBBLS 1.475 IV 19.13 Delta -.2501
  Debit 1.725 Position net delta .1691

The difference between the strike prices defines the maximum value of the spread, or 5 points. With a cost of 1.725 the maximum potential gain is 3.275 and there is ample time for it to reach its maximum value if the trend continues. Set the SU (stop/unwind) at a close under 80, the prior support and recent breakout level.

Selected Biotech Companies

Here are some specific suggestions for the sector. We suggest checking the fundamentals, identifying the upward sloping trendlines to use for the SU (stop/unwind) levels and look for the next reporting date before taking a position.

Genentech (DNA) 96.00

As we briefly wrote above DNA is in the process of being combined with Roche assuming they reach an agreement. The offer was 89 and the stock is now 96 as many analysts have concluded the final price should be closer to 100 per share. The current Historical Volatility is 48.17 while the August 100 calls are trading at .60 with an Implied Volatility of 20.33. The August 95 calls are trading at 2.175 with an Implied Volatility of only 16.44 suggesting that the current price is very near to the expected offer price that will conclude this deal. Therefore, we do not see any options opportunities for DNA.

Amgen Inc. (AMGN) 53.92.

At the top of our regular list of 5 stocks based on IV Index Mean vs 30D HV we find AMGN with IV Index Mean of 39.34%, a 30 day HV of 21.86% and a IV Index / HV ratio of 1.80 (positive volatility spread).

Based upon the amount of the positive volatility spread AMGN seems to be recipient of the option speculation for the next biotech to receive an offer.

Consider one of these suggestions.

• Sell AMGN Aug 50 put AMQTJ .72 IV 42.33 Delta .2142
  
  
• Sell AMGN Sep 45 put AMQUI .715 IV 45.92 Delta .1334
  
  
• Sell AMGN Sep 50 put AMQUJ 1.745 IV 41.77 Delta .2872

Comparing the Implied Volatilities (IV) of the above suggestions to the Historical Volatility (HV) of the stock at 21.86 reveals the positive volatility spreads and hence the edge in these trades.

Here are more in defined uptrends, all with positive volatility spreads (compare the HV to the IV).

Auxilium Pharmaceuticals Inc. (AUXL) 37.21. HV 36.53

• Sell AUXL Aug 35 put UQXTG 1.10 IV 57.34 Delta .3047

Human Genome Sciences Inc. (HGSI) 7.12. HV 45.25

• Sell HGSI Aug 7 ½ put HQITU .70 IV 68.97 Delta .5859

Savient Pharmaceuticals Inc. (SVNT) 27.55. HV 52.86

• Sell SVNT Aug 25 put UVPTE 1.375 IV 95.67 Delta .2956

And here are a few more. Since these don’t have positive volatility spreads take a look at these for longer-term bull call spreads.

Celgene Corporation (CELG) 74.54. HV 37.83

• Buy CELG Oct 80 call LQHJP 2.925 IV 33.86 Delta .3779
• Sell CELG Oct 85 call LQHJQ 1.525 IV 32.69 Delta -.2381
  Debit 1.40 Position net delta .1398

Cyberonics Inc. (CYBX) 27.56. HV 67.43

• Buy CYBX Jan 30 call QAJAF 2.90 IV 48.46 Delta .4844
• Sell CYBX Jan 35 call QAJAG 1.525 IV 47.97 Delta -.3065
  Debit 1.375 Position net delta .1779

Dendreon Corp. (DNDN) 5.69. HV 57.92

• Buy DNDN Sep 5 call UKOIA .87 IV 50.45 Delta .7791
• Sell DNDN Sep 7 ½ call UKOIU .28 IV 88.18 Delta -.2721 (some edge here).
  Debit .59 Position net delta .5070

Use a spread order and only pay up to .65.

Genzyme Corp. (GENZ) 75.71. HV 30.55

• Buy GENZ Oct 80 call GAAJP 2.75 IV 29.34 Delta .3927
• Sell GENZ Oct 85 call GAAJQ 1.275 IV 27.97 Delta -.2292
  Debit 1.475 Position net delta .1635

Gilead Sciences Inc. (GILD) 54.51. HV 41.88

• Buy GILD Nov 57 ½ call GDQKA 3.025 IV 32.46 Delta .4434
• Sell GILD Nov 60 call GDQKL 2.125 IV 31.72 Delta -.3506
  Debit .90 Position net delta .0928

Myriad Genetics Inc. (MYGN) 64.00. HV 55.56

• Buy MYGN Nov 65 call GSQKM 6.10 IV 42.93 Delta .5395
• Sell MYGN Nov 70 call GSQKN 4.20 IV 42.90 Delta .-4198
  Debit 1.90 Position net delta .1197

In order to include more suggestions we have deviated somewhat from our usual format. If you find any of the above suggestions of interest we encourage you to do the written trade plans including setting the SU (stop/unwind) levels. Further we suggest you write out the reason why the trade is being made, what we call the DR (Determining Rationale).

Previous Issues and Reader Response Request

All previous issues of the Digest can be found by using the small calendar at the top right of the first page of any Digest Issue. Click on any underlined date to see the selected issue. As usual we encourage you to let us know what you think about how we are doing and what you would like to see in future issues. Send us your questions or comments, or if you would like for us to take a look at a specific stock or ETF just let us know. Use the blog response at the bottom of the IVolatility Trading Digest™ page on the IVolatility.com Website.

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