Trader bets on big drop for biotech

Biotech stocks were on the rise this summer, but one trader sees the rally as short-lived.

On Thursday when the S&P Biotech ETF (XBI) was at $63.50, one trader bought a bear put spread in the ETF. The trader bought approximately 2,000 of the Sept. 30 62.50-strike puts and sold the Sept 30 57.50-strike puts for $1.25, or $125 per options contract. This is a bet that the XBI will fall as low as $57.50, or 8 percent from current levels.

While it may seem as though the trader could be betting on a less dramatic drop in the XBI, Dan Nathan of RiskReversal.com explains that the trader could be hedging against the summer's biotech rally.

"It's really important that the XBI is down 13 percent from its all-time highs made in July of 2015," he said Thursday on CNBC's "Fast Money." "A lot of people have been trying to pick a bottom as the stock has been making a series of higher lows over the last three to five months or so."

Looking to a chart of the XBI, Nathan points out that the stock has consolidated above a $60 support rather than dropping below. This leads him to think that the trader is making a short-term safe play in the biotech sector.

"I think that's the level, possibly, this trader is looking to play for a short-term breakdown or some protection against a basket of some biotech stocks," said Nathan. "But if it holds here, there's a really good setup from a technical basis."

"I think that if you're long biotech stocks, volatility, the price of options in the XBI is cheap if you're looking to hedge," he added.

Despite the summer rise, XBI is still down more than 10 percent year to date.

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    Melissa Lee is the host of CNBC's “Fast Money” and “Options Action.”

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