How to play with biotech stocks

The selloff of biotech stocks lately is quite brutal. If you are caught up in it, you must be feeling a lot of pain.  Due to the nature of the biotech business, it is really challenging to predict which way it may go short term, even if you are great in science. This is especially true to bet for the so-called clinical stage biotech companies, which have no approved products on the market yet but only those in clinical trials. The binary result of a trial could turn a stock into moon if positive, or into hell if negative. I was asked how to play with it. There is really no easy way to play with such stocks with extremely high emotions attached. Covered calls are relatively safe but the safety is limited to how much you've covered and the upside is capped as well. For such a binary trade with high volatility, straddle (buy call and put at the same time. Just google for more details) is often used but it costs a lot to start with. I think it is better to use this strategy shortly before the expected PDUFA date (the FDA expected decision date).




Personally I tend to use a  "managed" covered call/spread strategy, for which one needs to actively monitor and adjust the position accordingly. Here is the real example:


I talked about JUNO a while ago when it got clobbered and I set up a JUNO call spread around $27. Given JUNO was wandering for quite a few weeks around $30, my short arm started to have good profit. Just about 3 weeks ago JUNO jumped to $34 due to positive Kite data. This kind of move is often emotionally charged and rarely sustainable. So I covered the short arm with some profit and at the same time, I sold another deep in the money (ITM) calls (down to $25) against the long arm, expecting JUNO would correct fast. This way, I virtually locked the big profit from the long arm while waiting for the correction. That's exactly what has been happening now. So I'm now sitting with a big profit from the ITM short arm and I will lock the profit as well when I feel the correction is done. This way, I could end up with an almost free trade with JUNO, since over long term I'm quite bullish with it and I'd like to stay with it. This of course requires good understanding of option and technical analysis (TA). For clinical stage biotech stocks you cannot analyze them fundamentally but only with TA to get a hint if overbought or oversold.


I'm currently working on another biotech trade with a similar strategy, SRPT. You may recall that I discussed about SRPT recently after it got an unexpected approval: Technically its long-term trend is quite bullish. But the concern is about its short-term trend. It doubled yesterday and got further pushed up today. I think this has a lot to do with short squeeze. The 2 days of strong rally has pushed the stock to its all time high around $55 and it has been unbelievably overbought at the moment. I can hardly believe it has the strength to simply go significantly higher from here without coming back first. So in the near term, I think SRPT has a high risk of correction towards $40 or so. It would be a good buy for long term if it indeed comes down to that level. I was a bit early with this trade and it went against me for a few more days by continuously going up to peak around $62. But I was convinced that it had too much froth in it that must be squeezed out first. So I even sold naked calls against the stupidly expensive prices.  Looks like my patience pays off. SRPT is undergoing the expected correction as I'm writing and it has got a haircut by dropping over $20 in the past 2 weeks and closed right around $40 today.  With that my short arm is more than paying off my long arm and I virtually get paid to wait for its next leg up.


Trading with biotech stocks is never an easy job. Simply buying and holding has great risks and using some hedge is a much better way to play with this sector.