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Market MeasuresHow Risky Are Biotechs? | May 11, 2016
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    Market MeasuresHow Risky Are Biotechs?May 11, 2016

    We like to use High Implied Volatility Strategies when trading so of course we search for underlyings with high Implied Volatility (IV) and high Implied Volatility Rank (IVR). There is more though to selling option premium than just high IV. Liquidity is one key consideration and another important one is risk in the underlying. The Biotech sector is down around 20% year-to-date while the broader market is generally flat. We can use our dough software to check liquidity but what about the risk?

    A graph of MDVN, the largest component of the XBI (S&P Biotech ETF) displayed wild up and down price swings. This is typical of Biotechs which are influenced by new discoveries, Phase III trials and possible FDA approvals. Around only 25% of the the stocks in XBI are profitable as compared with around 89% of the S&P 500. A table of the top 4 Biotechs (by market capitalization) was displayed. The table included the company, capitalization, IV and IVR. They all had low Implied volatility and IVR leaving little opportunity for premium sellers.

    We like to sell premium at tastytrade because this allows us to take advantage of theta (time decay), because we believe IV is mean-reverting (so we sell when it is high) and because the expected move implied in the price of the options is very often less than the actual move. Because Biotechs are subject to the news events plus the risk of takeovers, our strategy can be disrupted.

    A study was conducted using the top 50 stocks within the Biotech ETF. We wanted to see how many of the stocks fell within their expected (implied) price range over 30 days. We compared the results against the S&P 500. The S&P fell within its range 88% of the time and the Biotechs 78%. We then had to factor in the potential for large price swings.

    For more on Biotechs see these segments of “Market Measures”:

    Watch this segment of “Market Measures” with Tom Sosnoff and Tony Battista for the valuable takeaways and the answer to the question of whether selling premium in the Biotechs is worth the risk.

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