With VIX approaching the previous lows that should act as support, a short put position added to a long call will increase the delta and reduce the cost without materially increasing the risk
Last week?we noted a pullback in the US Dollar Index was likely to begin Monday or Tuesday regardless of the comments after the Federal Reserve Open Market Committee meeting Wednesday and indeed it did. Now the biotechnology sector along with Health Care Select Sector SPDR ETF (XLV) 74.90 appears overbought and due for similar pullbacks after positive biotech news Friday. We have a put suggestion foriShares Nasdaq Biotechnology (IBB) below, but first a VIX update since if the hot biotech group corrects as expected it will likely take the entire market lower.
CBOE Volatility Index? (VIX)
Last week?s suggestion was a disappointment since VIX declined Monday contrary to expectations, and then declined substantially both Wednesday and Friday. While Wednesday?s decline can easily be attributed the Fed comments, Friday?s could be related to the bullish activity in the biotech sector.
Now with VIX approaching the previous lows that should act as support, a short put position added to a long call will increase the delta and reduce the cost without materially increasing the risk since volatility will not go to zero and the April contract has more than three week to expiration.
Based upon the ask price for the call and the bid for the put the debit is .25 with a delta of 1.00 representing a lot of hedge power at a small cost. The only issue here is getting the position established before the market declines.
?iShares Nasdaq Biotechnology (IBB) 366.52, up 21.19 or 6.14% for the week – too far too fast?
The current Historical Volatility is 15.65 and 17.26 using the Parkinson’s range method, with an Implied Volatility Index Mean of 24.79 up from 24.00. The 52-week high was 39.98 on April 14, 2014 while the low was 19.37 on August 27, 2014. The implied volatility/historical volatility ratio using the range method is 1.44 so option prices are somewhat expensive compared to the recent movement of the stock, but the implied volatility will increase as the expected correction begins. The put call ratio is bearish at 3.10. Friday?s option volume was 28,206 contracts traded compared to the 5-day average volume of 15,160.
Consider this put spread idea.
Summary
Comments after the Federal Reserve Open Market Committee meeting last Wednesday eased apprehension that had been building like pressure in a teapot that a hike in the federal funds rate will occur any time soon. Accordingly, the interest sensitive underlying issues as well as the US Dollar Index began correcting as S&P 500 Index promptly bounced off the upward sloping trendline and continued marching higher. Now the previous high at 2119.59 is next upside target while the leading biotechnology sector looks overbought and due for a pullback.
With a slight volatility edge, using the ask price for the buy and the mid for the sell presuming some price improvement is possible, the debit is 1.85 an attractive 18.5% of the distance between the strikes. Use a close back above Friday?s high of 374.97 as the SU (stop/unwind).
The VIX suggestion above is based on the ask price for the buy and bid for the sell. The IBB suggestion presumes some price improvement is possible. Monday?s option prices will be somewhat different due to the time decay over the weekend and any stock price change.