After Gilead's Drop: Hedging 5 Biotechnology Stocks

by: David Pinsen

Shares of Gilead Sciences, Inc. (NASDAQ:GILD) closed down 14.25% on Friday, after the company reported disappointing clinical results for a Hepatitis C drug. Despite the drop, shares of Gilead are still up more than 37% over the last 13 weeks. Gilead is one of a number of biotech stocks that have posted double digit gains over that time frame (a few other biotechs have posted triple digit gains over the same time frame). To narrow down the list, I used Fidelity's screener to look for biotech stocks that had gained more than 10% over the last 13 weeks and had positive PEG ratios of 1.20 or below. Gilead made that screen with a PEG of 1.06. In this post, we'll look at hedging Gilead and four other biotechs that made this screen. The table below shows the costs, as of Friday's close, of hedging these five biotechs against greater-than-24% declines over the next several months, using optimal puts.

A Comparison

For comparison purposes, I've added the iShares Nasdaq Biotechnology Index ETF (NASDAQ:IBB) and the PowerShares QQQ Trust ETF (NASDAQ:QQQ) to the table. First, a reminder about what optimal puts are, and a note about decline thresholds. Then, a screen capture showing the optimal puts to hedge one of the stocks below, Celgene Corporation (NASDAQ:CELG).

About Optimal Puts

Optimal puts are the ones that will give you the level of protection you want at the lowest possible cost. Portfolio Armor uses an algorithm developed by a finance Ph.D. to sort through and analyze all of the available puts for your position, scanning for the optimal ones.

Decline Thresholds

In this context, "threshold" refers to the maximum decline you are willing to risk in the value of your position in a security. You can enter any percentage you like for a decline threshold when scanning for optimal puts (the higher the percentage though, the greater the chance you will find optimal puts for your position). I have used 24% decline thresholds for all of the names here.

The Optimal Puts for CELG

Below is a screen capture showing the optimal put option contract to buy to hedge 100 shares of Celgene against a greater-than-24% drop between now and July 20th. A note about these optimal put options and their cost: To be conservative, we calculated the cost based on the ask price of the optimal puts. In practice, an investor can often purchase puts for a lower price, i.e., some price between the bid and the ask (the same is true of the other names in the table below).

Click to enlarge:

Hedging Costs as of Friday's Close

The hedging costs below are as of Friday's close, and are presented as percentages of position values. The stocks are listed in descending order of their price performance over the last 13 weeks.



13 Week Price Performance

Hedging Cost

AMLN Amlyn Pharma 81.4% 8.53%*
GILD Gilead Sciences 37.4% 3.62%**
ACOR Acorda Therapeutics, Inc. 23.2% 12.4%*
CELG Celgene Corp 19.8% 1.89%*
UTHR United Therapeutics Corp. 18.3% 2.43%**
IBB iShares Nasdaq Biotech Index ETF 21.9% 2.10%***


PowerShares QQQ Trust ETF



*Based on optimal puts expiring in July

**Based on optimal puts expiring in August

***Based on optimal puts expiring in September

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.