Covering IBB Short Sale Into Historic Market Sell-Off

Summary

• The coronavirus is a tragic, global event that has negatively impacted markets. This downside catalyst has given us the worst week since the financial crisis.
• Current market weakness is giving us a profitable opportunity to cover our 1/7/20 short sale of the IBB biotech ETF.
• Resultantly, covering this profitable short now gives us an opportunistic cash position to employ into any coming relief rally.
• Our 1/7/20 article stated our belief that 2020 would be a trading range market. If this current volatility continues this year, then we are well positioned to deliver significant market outperformance as a short-term trader.
• Trader's Idea Flow seeks to deliver performance in all market seasons. We believe that trading range markets and also bear markets present ideal conditions for our trading philosophy to deliver significant outperformance.
• This idea was discussed in more depth with members of my private investing community, Trader's Idea Flow. Get started today »

Our 1/7/20 trading call to sell short was based upon our view that the market came into 2020 fully valued. By some measures we believed the market was overvalued. We selected the iShares Nasdaq Biotechnology ETF (NASDAQ:IBB) IBB as a trading vehicle for our short trade with the view that the IBB would deliver greater downside volatility. Today we are choosing to cover our short into the weakness of this week's historic selloff due primarily to the global coronavirus epidemic. We may be early in our cover, but this has been a successful short-term trade delivering a gain of nearly 7%.

The IBB ETF seeks investment results that correspond generally to the price and yield performance of the Nasdaq Biotechnology Index. The IBB often trades with the overall market and carries a Beta coefficient of 1.33 making it 33% more volatile than the entire market. As short-term traders, we are attracted to greater volatility that may enable our trading calls to deliver superior performance if we are correct in our speculation on the direction of our trading call. Conversely, if we are wrong in our trading call, then this higher Beta will increase our risk for loss of capital on the trade. We chose the IBB as the vehicle to implement our short sale on the market in the hope of achieving greater volatility to the downside of the market. Importantly, the IBB ETF would largely ameliorate any M&A activity risk that would accompany the short sale of some individual biotech stocks.

Data by YCharts

We also stated in our 1/7/20 article that we believed 2020 would be a trading range market. In the scenario of a trading range market the ability to generate gains in a down market is extremely valuable. Furthermore, closing our profitable short trade has now given us a cash position to return to the long side of the market when and where we see opportunity. This type of successful trading where we are selling tops and buying bottoms enables us to deliver significant outperformance in a trading range market. For instance:

• We sold the top of the market in early January with our short sale.
• We covered that short sale Feb. 28 into what we believe is a short-term trading bottom with a 7% profit on the cover of our short sale trade. We may be early with our cover but as the old adage goes "you never go broke by taking a profit." Candidly, we are pleased to earn a 7% gain on this trade in under two months holding time in a market that has become challenging to earn any profit at all.
• Our cash position now provides us with the opportunity to return to the long side of the market when and where we choose. We have successfully completed the process of selling high, now we seek to identify a trading idea that will enable us to buy low. Stay tuned as we implement this strategy in the near term.

Perhaps next there will be a trade back to the long side of the market based upon a relief rally from a short-term oversold condition. It's our experience that extreme bad news is often followed by less extreme bad news. This relatively "less bad" news can be the catalyst for a relief rally in markets. We want to watch the chart for a bottoming pattern and also keep our attention on the macro developments surrounding the coronavirus catalyst for a buy signal.

Perhaps news of progress on a vaccine may be a part of the next news cycle. This could be a profitable short-term trade to the long side of the market that traders with cash can capitalize upon. Achieving successful consecutive trades to the short side and then the long side of the market early in a trading range year might deliver superior performance above the S&P 500 for the entire calendar year. If 2020 continues to be a trading range market, as we projected in our 1/7/20 article, then our early trading success may now have us on track to significantly outperform the S&P 500 for the entire year. This outperformance is the goal of a trader and indeed one of the advantages of trading vs the buy and hold strategy.

Summary

We believed the market was set-up for a correction coming into 2020. We expected that at least one negative market catalyst would emerge to bring the market back down closer to fair value. Currently, the coronavirus catalyst may be combining with the rise of Bernie Sander's political fortunes, which are two negatives for the market.

Data by YCharts

When markets are overvalued you know that a negative catalyst will eventually come along to cause a correction, but you may not always foresee what that specific catalyst will be. - Bull & Bear Trading

Because some kind of bad news for any overbought market is inevitable, the overbought status of any market means that some negative catalyst is forthcoming. We saw an overbought market. We identified a trading vehicle with strong volatility in the IBB. We waited for a negative catalyst. We are now covering our successful short.

Conclusion

The coronavirus is a tragic occurrence and we wish all a speedy recovery to health. We pray that containment of this epidemic will now begin to make positive progress globally. We hope that damage to global economies will be minimized. Good news generally follows bad news. We believe the coming news cycle in the weeks ahead will swing away from the current near-panic status being voiced in the media and that markets will find a bottom. In fact, we are watching closely now for a bottom on the chart. The chart combined with the macro fundamental scenario may provide us with the signal we are seeking to cover our successful short of the IBB.

If we can continue to execute our strategy of buying low and selling high throughout the rest of 2020, then we will have achieved our mission as traders and delivered for our community in the Trader's Idea Flow Marketplace service on Seeking Alpha.

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in IBB over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.