Knives are out again for biotechnology stocks amid a rally that has burned skeptics repeatedly for six years.
Demand for options tied to declines in an exchange-traded fund tracking the companies rose to the highest level in three years relative to bullish ones, according to data compiled by Bloomberg. The Nasdaq Biotechnology Index has risen 549 percent since March 2009, including a 3.8 percent advance last week.
Interest in bearish options on drug developers has jumped in the last year after the group was called out as overvalued by Federal Reserve Chair Janet Yellen on two occasions. Biotechs are selling stock at a pace not seen in a decade and one concern is that something will disrupt the money spigot.
“The sector is dependent on capital that might shy away at the first sign of weakness,” Goldman Sachs derivatives strategists Katherine Fogertey and John Marshall wrote in a June 17 client note. “Recent pipeline setbacks have increased concern of this going forward.”
Biotech companies are doing follow-on stock offerings at the fastest pace in more than 10 years. In the first quarter, biotech and pharmaceutical companies used 93 share sales to reap $18.7 billion, three times more than in 2014, according to data compiled by Bloomberg.
Relative Strength
Price momentum is picking up in the stock market. On Monday, the relative strength index for the Nasdaq Biotech gauge climbed above the 70 threshold that some traders view as a sign of caution. That marked the first time in three months it exceeded the level.
The biotech index decreased 0.4 percent at 4 p.m. in New York.
“Biotech stocks have had a speculative fervor to them for some time now,” Todd Lowenstein, who helps manage $16 billion at HighMark Capital Management Inc. in Los Angeles, said by phone. “Of any part of the market, this is the one with the most bubble-like characteristics, without question.”
The Nasdaq Biotech Index has seen five pullbacks of more than 6.6 percent in the past year, though the gauge recovered the loss within about a month each time.
Goldman Sachs noted that clinical trial setbacks have caused volatility in companies like Aerie Pharmaceuticals Inc., Celladon Corp. and Eleven Biotherapeutics Inc. -- all drug developers that have conducted an initial public offering since October 2013.
Valuation Forecast
The Nasdaq Biotech Index trades at 53 times analyst earnings estimates, according to data compiled by Bloomberg. That compares to a 12-month forward forecast of 18 times for the Standard & Poor’s 500 Index.
Biotech bulls like Randy Warren of Warren Financial Service & Associates Inc. see no reason to worry. Bidding wars for targets in the industry have driven takeover premiums to unprecedented heights.
“The customer base for biotech won’t stop buying,” Warren, who manages more than $100 million at Exton, Pennsylvania-based Warren, said by phone. “This sector is probably the best-placed to get any kind of growth, and it’s not going to go away quickly.”
Options protecting against a 10 percent drop in the iShares Nasdaq Biotechnology ETF cost 9.8 points more than calls betting on a 10 percent rise on June 10, according to three-month data compiled by Bloomberg. That was the highest since August 2012 and above the 7-point average for the price relationship known as skew since the start of 2013.
Short interest in the ETF, or bets that the stock will drop, sits at 6 percent of shares outstanding. That’s above the measure’s three-year average of 5 percent, according to data compiled by Markit Ltd.
“When credit is available, there’s risk appetite to fund speculative investments -- people are willing to bet on all sorts of horses to see who will win the race,” HighMark’s Lowenstein said. “Most industries ultimately shake out. There’s going to be pain ahead for biotech.”