Breaking Down Biotech ETFs With Leverage

Amid political grandstanding and valuation concerns, among other factors, the once high-flying health care sector has swiftly reversed course for the worse in recent weeks and the pain has been especially acute for biotechnology equities and exchange traded funds.

Over the past month, four of the worst-performing non-leveraged ETFs, including the worst overall, are health care funds and three of those four are biotech ETFs. However, some bearish leveraged biotech ETFs, namely the Direxion Daily S&P Biotech Bear 3X Shares LABD, from the bearish cloud that has been cast over the biotech space.

“Since peaking on July 20, the S&P 500 Biotech Index has fallen 23%, double the broader S&P 500 Index during same period. It all started to unravel when Turing Pharmaceuticals raised the price of a 30-year old drug used for HIV treatment, by 5,000% to $750 per pill. Shortly after the New York Times published a story on Turing and other drug companies that hiked up drug prices, Hillary Clinton attacking drug companies for “price gouging”. Democratic lawmakers piled on, distributing a letter calling for a subpoena to force Valeant Pharmaceuticals to provide documents related to price increases for two heart drugs. Many biotech stocks fell 20% to 35% or more in a few trading days, as selling accelerated at the start of the week,” according to a note out today from Direxion, the second-largest issuer of inverse and leveraged ETFs. 

The tumult has aided the ascent of LABD, an ETF that attempts to deliver triple the daily returns of the S&P Biotechnology Select Industry Index. That is the same index tracked by the SPDR S&P Biotechnology ETF XBI and that is a good thing for LABD because XBI, the third-largest biotech ETF, is one of the worst-performing biotech funds over the past month. 

Although LABD has surged nearly 28 percent over the past month, a case can be made that there is more upside ahead for the leveraged ETF.

“Major market participants have made cautious remarks on a bubble possibility regarding the biotech space. Even Fed Chair Janet Yellen has warned that “valuation metrics” in biotech “appear substantially stretched”.  The sector’s valuations, thinning pipelines and numerous stalled phase two trial drugs have started to make some investors nervous. And then there’s the new threat to innovative biotech companies: 'biosimilars,'” said Direxion.

Some traders have acknowledged the case for LABD. For the five days ended Oct. 1, LABD's volume was more than 125 percent above the trailing 20-day average, according to Direxion data. 

However, data also suggest that bullish biases are leading traders to embrace the recently struggling Direxion Daily S&P Biotech Bull 3X Shares LABU, LABD's bullish equivalent.

“Venture cash continues to boost the industry, as the rise in IPOs within the space over the 15 years has given investors more confidence in the growth prospects and research advancements of biotech.  According to PricewaterhouseCoopers, over $2.3B of venture capital investments have flowed to the biotech space in the second quarter of this year.  This is the highest amount of inflow to the space since 1995,” notes Direxion.

For the five days ended Oct. 1, LABU's volume was 158.1 percent above the trailing 20-day average. LABU has seen inflows of almost $174 million since coming to market in late May, making it one of the most successful new ETFs to debut this year.