Just before noon ET on Friday, May 27, Doug Kass posted the following in his daily log on Real Money Pro:

“I added to SPDR S&P Biotech ETF (XBI) this morning.

And I sold calls at attractive prices against him.”

This piqued my interest.

I have been slowly adding to my XBI holdings via covered calls for several months now. I have no doubt it will be a good long-term trade, but Doug is more renowned than me for market timing, so I followed him into that trade on Friday with a few more buy-write orders on the XBI.

There are several reasons to believe that the XBI has indeed finally bottomed out after falling around 60% from its starting point in 2021. First, from a technical standpoint, the ETF appears to have formed a trough here in the second half of May.

Second, the small- and mid-cap biotech space has become more than cheap. Take Graphite Bio (GRPH), for example. This early-stage gene-editing development concern has been beaten to the point where it has a market capitalization of around $130 million. At the end of the first quarter, the company had approximately $350 million of net cash on its balance sheet. Graphite Bio is one of hundreds of small biotech stocks currently trading at levels below the cash on its balance sheet.

The only similar event that I can recall in any industry like this was for small internet stocks at the end of the internet crash. I remember buying a small search engine company called Ask Jeeves (ASKJ) in late 2001 or early 2002 for two dollars a share. It had $3.75 per share in net cash on its balance sheet at the time. In 2005, it was bought out for $26.00 per share.

A similar good market in the biotech sector is starting to trigger a pick-up in M&A deals. Most of them are small at the moment, but they are expected to grow significantly in the second half of 2022. Big Pharma certainly has a huge amount of cash and financial flexibility to expand its footprint in oncology, rare diseases, CNS and others. market niches in a major way.

How can an investor take advantage of this?

Given the blows that biotech has taken over the past few quarters, an investor is likely to gain more by buying strong individual biotech stocks at year-end if we manage to only have a neutral investment environment. in the future. However, the following trade offers a more than solid return and offers significant risk mitigation and diversification.

Options Strategy

Here is how one can initiate a position in XBI via a covered call strategy. Covered buy orders involve buying a stock and simultaneously selling call strikes just out of the money against the new position.

Using December’s $70.00 buy strikes, create a covered buy order with a net debit between $60.20 and $60.40 per share (net stock price – premium option). This strategy offers 15% downside protection, just above the upside potential, even if the stock goes down a little over the life of the option.

(Please note that due to factors such as low market capitalization and/or insufficient public float, we consider GRPH to be small cap stocks. You should be aware that these stocks are subject to more risk than stocks of large companies, including greater volatility, lower liquidity, and less publicly available information, and that releases like this can affect their stock price.)

(Bret Jensen is a regular contributor to Real Money Pro. Click here to learn more about this dynamic market news service for active traders and to receive daily columns and trade insights from Paul Price, Doug Kass, Peter Tchir and others.)