« July 2008 »

IVolatility Trading Digest™

Volume 8, Issue 28
Biotech Buzz

Trade selection using volatility as the primary criteria. Different trades for different volatility opportunities.
Please read IVolatility Trading Digest™ Disclaimer at the very bottom of this page

To add comments or to ask questions please click here (or use the blog "COMMENTS" link at the very bottom of the blog page).

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.


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 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.

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.

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

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

Savient Pharmaceuticals Inc. (SVNT) 27.55. HV 52.86

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

Cyberonics Inc. (CYBX) 27.56. HV 67.43

Dendreon Corp. (DNDN) 5.69. HV 57.92

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

Genzyme Corp. (GENZ) 75.71. HV 30.55

Gilead Sciences Inc. (GILD) 54.51. HV 41.88

Myriad Genetics Inc. (MYGN) 64.00. HV 55.56

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.


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 WHAT ARE YOU REFERRING TO WHEN TALKING ABOUT EDGE..

Posted by Carl on July 29, 2008 at 03:45 PM EDT
Website: http://www.quideco.com.ve

On the DNDN bull call spread, you make specific reference to 'Use a spread order and only pay up to .65.' 1. Is using a spread order not the usual way to enter a spread? Please comment on circumstances where you would not use a spread order. 2. Why did you set max debit at .65? At .65 the profit / loss ratio is 185 / 65 = 2.8. At .75, the ratio is 2.3, better than the potential on the following GILD and MYGN plays. Glad to see you back writing the digest - always great info.

Posted by David on August 05, 2008 at 08:27 AM EDT

Carl, Thanks for the question about edge. First we want to apologize for the delay in responding. It seems our response notification system had some problems. We compare the relative prices of options in terms of their implied volatility. For example an option with an implied volatility of 50.45 is cheaper than one with an implied volatility of 88.18. In addition, it is cheaper than what would be suggested by the movement of the stock, since it has a Historical Volatility of 57.92. So in this case the call we are buying is cheaper that the one we are selling and cheaper that then stock movement would suggest. We want to by inexpensive options and sell expensive ones. This is the edge. It is the same concept that the casino uses to sell expensive bets to gamblers. Jacktrader

Posted by Jacktrader ( on September 08, 2008 at 11:27 PM EDT

David, Thanks for the comment and question about spread orders and the DNDN suggestion. First we want to apologize for the delay in responding. It seems our response notification system had some problems. We think spread orders are best. Some will attempt to leg into a spread by doing one side and then the other hoping to pick up some advantage. While this is possible it requires a good bit of work, creates uncertainty and creates price risk as the stock my not go in the desired direction. The calculated debit for the suggestion was .59 and this is based upon the mid prices between the bid and offer prices. As a practical matter you will be required to give up some of the bid offer differential in order to get the trade done. In this case by suggestion was to only give up .06. More than that would mean giving up too much of the edge that was in the position. Jacktrader

Posted by Jacktrader ( on September 08, 2008 at 11:46 PM EDT

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IVolatility Trading DigestTM Disclaimer
IVolatility.com is not a registered investment adviser and does not offer personalized advice specific to the needs and risk profiles of its readers.Nothing contained in this letter constitutes a recommendation to buy or sell any security. Before entering a position check to see how prices compare to those used in the digest, as the prices are likely to change on the next trading day. Our personnel or independent contractors may own positions and/or trade in the securities mentioned. We are not compensated in any way for publishing information about companies in the digest. Make sure to due your fundamental and technical analysis homework along with a realistic evaluation of position size before considering a commitment.

Our purpose is to offer some ideas that will help you make money using IVolatility. We will also use some other tools that are easily available with an Internet connection. Not a lot of complicated math formulas but good trade management. In addition to Volatility we use fundamental and technical analysis tools to increase the probability of success and reduce risk. We prepare a written trade plan defining why the trade is being made, what we call the "DR" (determining rationale) and the Stop/unwind, called the "SU".