With apologies to John Lennon and the Plastic Ono Band for the title of the article on VXN and QQQ puts.
The recent red-hot rally in stocks, especially the NASDAQ 100 names, has brought the bulls back charging and put the bears in hibernation. Whether the momentum will proceed or not is actually uncertain.
One thing that is for certain, though, is that some stock measures are definitely getting more extreme, which warrants caution. Protecting or playing for some potential downside is something to noticeably consider.
Quite than simply exiting or shorting stocks, using option strategies makes more sense in the present environment.
Listed below are three big explanation why now is perhaps an opportune time to be buying bearish puts, either as a portfolio protection or a short-term speculative trade.
Implied Volatility
Most of you’re probably acquainted with the VIX, sometimes known as the Fear Gauge. It’s a measure of option prices within the S&P 500. How a lot of you already know that the NASDAQ 100 has the same instrument to measure implied volatility -VXN- or “Vixen”. Below is the definition from the Chicago Board Options Exchange (CBOE) for the VXN. For our purposes, we’re substituting QQQ for NDX since QQQ is far more heavily traded.
The Cboe NASDAQ-100 Volatility IndexSM (VXN) is a key measure of market expectations of near-term volatility conveyed by NASDAQ-100® Index (NDX) option prices. It measures the market’s expectation of 30-day volatility implicit in the costs of near-term NASDAQ-100 options. VXN is quoted in percentage points.
The VIX has dropped sharply recently as stocks have rallied previously month. VIX closed just above the bottom levels of the yr on Friday because the S&P 500 rallied, albeit well shy of yearly highs.
VXN, nonetheless, did close at a latest yearly low on Friday because the NASDAQ 100 (QQQ) closed at a latest yearly high. Also, VXN closed at the bottom level since January 2022.
A fast comparison of the last time QQQ was at comparable pricing will show how much the drop in VXN cheapens the worth of puts. The comparative option montages are shown below.
On August 25 of last yr, QQQ closed at $320.58. The November 18th $315 puts had 85 days until expiration and were priced at $14.00. IV was just over 29.
Fast forward to Friday, and QQQ closed at $320.93, so only 38 cents higher than back in August. The June thirtieth expiration $315 puts had 91 days to expiration, so a number of more days longer than the same November 18th expiration puts from back in August. The June 30th puts were priced at $11.00. IV was just below 24.
Putting all of it together, the marginally out of the cash $315 puts from last August were trading $3.00 cheaper than the virtually similar puts are trading now.
One other option to have a look at it, the puts back in August cost 4.37% the worth of QQQ in comparison with just 3.43% now. All because IV dropped from 29.04 to 23.76. To me, buying puts at a less expensive price (and the most affordable price in quite some time) is rarely a nasty thing.
VXN can also be a reliable market timing tool, very very like the VIX in that regard. Drops to comparatively low levels of VXN almost invariably coincide with short-term tops in QQQ, because the chart below shows. Is the QQQ near a top$ The VXN is implying so.
Technicals
The NASDAQ 100 (QQQ) is getting overbought on a technical basis. 9-day RSI is now over 70. Bollinger Percent B just broke past 100. MACD hit an extreme. Shares are trading at a giant premium to the 20-day moving average. Last times these indicators all aligned similarly marked a short-term top in QQQ.
NASDAQ 100 (QQQ) is getting a bit out over the skis on a comparative basis in comparison to the opposite three major indices. The Nazzy is showing a spectacular gain of over 20% up to now in 2023. Compare that to the still very respectable gain of virtually 7.5% for the S&P 500 (SPY) and it is simple to see just how much QQQ has rallied versus other stocks in Q1. If you happen to compare the gains of QQQ to those of either IWM (Russell 2000) or DIA (Dow Jones Industrials) the out-performance is much more astounding.
Actually, some outperformance by the NASDAQ 100 is warranted given it was the worst performing index of the massive 4 in 2022. That outperformance, nonetheless, is now attending to an extreme. Search for QQQ to be an underperformer over the approaching months because the comparative spread converges back towards the more traditional relationship.
Fundamentals
Two stocks, Microsoft (MSFT) and Apple (AAPL), account for over 25% of the NASDAQ 100 Index weighting. In addition they comprise over 13% of the S&P 500-the first time two stocks were this powerful since IBM and AT&T within the late Nineteen Seventies. Plus, they’re the one stocks with a $2 trillion plus market cap.
To a big degree, as go these two stocks so goes the NASDAQ 100 and stocks generally. Taking a look at the valuations of those two mega cap names will provide an excellent insight into valuations generally for QQQ.
The Price/Sales ratio for top weighted Microsoft (MSFT) is now back well over 10 and at the very best multiple since August of 2022 when the QQQ peaked.
Number two Apple paints the same picture.
Price/Earnings ratio in MSFT is much more extreme, now at a better level than back on the previous QQQ peak in price. All this even with rates of interest increasing sharply in that point frame-which should cause multiples to contract.
Option prices are low cost. The NASDAQ 100 is overbought technically and overvalued fundamentally. Combining those two statements together means purchasing puts now on QQQ is less expensive and far more sensible than anytime this yr. All we want is the market to return to some semblance of sensibility to profit on a put play.
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All of the Best!
Tim Biggam
Editor, POWR Options Newsletter
QQQ shares closed at $320.93 on Friday, up $5.25 (+1.66%). Yr-to-date, QQQ has gained 20.71%, versus a 7.46% rise within the benchmark S&P 500 index throughout the same period.
In regards to the Creator: Tim Biggam
Tim spent 13 years as Chief Options Strategist at Man Securities in Chicago, 4 years as Lead Options Strategist at ThinkorSwim and three years as a Market Maker for First Options in Chicago. He makes regular appearances on Bloomberg TV and is a weekly contributor to the TD Ameritrade Network “Morning Trade Live”. His overriding passion is to make the complex world of options more comprehensible and due to this fact more useful to the on a regular basis trader. Tim is the editor of the POWR Options newsletter. Learn more about Tim’s background, together with links to his most up-to-date articles.
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