With apologies to John Lennon and the Plastic Ono Band for the title of the article on VXN and QQQ puts.
The recent scorching rally in stocks, particularly the NASDAQ 100 names, has brought the bulls back to the charge and sent the bears into hibernation. Whether or not the momentum will continue is certainly uncertain.
One thing is certain, however, and that is that some stock metrics are definitely getting more extreme, warranting caution. Protecting or playing for a potential downside is something to seriously consider.
Rather than simply exiting or shorting stocks, using options strategies makes more sense in today’s environment.
Here are three big reasons why now may be the right time to buy bearish put options, either as portfolio protection or as a short-term speculative trade.
Most of you are probably familiar with the VIX, sometimes called the Fear Gauge. It is a measure of option prices in the S&P 500. How many of you know that the NASDAQ 100 has a similar instrument to measure implied volatility -VXN- or “Vixen”. Below is the Chicago Board Options Exchange (CBOE) definition for VXN. For our purposes, we replace QQQ with NDX because QQQ is much more traded.
The Cboe NASDAQ-100 Volatility IndexSM (VXN) is a key measure of market expectations for short-term volatility conveyed by the NASDAQ-100® Index option prices (NDX). It measures the market’s anticipation of the 30-day volatility implied in short-term NASDAQ-100 option prices. VXN is indicated in percentage points.
The VIX has fallen sharply recently as stocks have rallied over the past month. VIX closed just above the year’s lows on Friday as the S&P 500 rallied, albeit well below yearly highs.
VXN, however, closed at a new yearly low on Friday as the NASDAQ 100 (QQQ) closed at a new yearly high. Additionally, VXN closed at the lowest level since January 2022.
A quick comparison of the last time QQQ was at comparable prices will show how much the decline in VXN depreciates the price of put options. The comparative option assemblies are shown below.
On August 25 of last year, QQQ closed at $320.58. November 18e The $315 put options had 85 days to expiration and were priced at $14.00. IV was just over 29 years old.
Fast forward to Friday, and QQQ closed at $320.93, just 38 cents higher than August. The $315 put options expiring June 30 had 91 days to expiration, so a few days longer than the similar November 18.e expiration sets back in August. June 30e put options were priced at $11.00. IV was just under 24 years old.
Overall, last August’s slightly out-of-the-money $315 put options were trading $3.00 less than virtually similar put options currently trading.
Another way to look at it, discounts in August were 4.37% of QQQ’s price compared to just 3.43% now. All because IV went from 29.04 to 23.76. For me, buying puts at a much cheaper price (and the cheapest price for a while) is never a bad thing.
VXN is also a reliable market timing tool, very similar to VIX in this regard. Declines to relatively low levels in VXN almost invariably coincide with short-term highs in QQQ, as shown in the chart below. Is QQQ close to a high $ VXN implies.
The NASDAQ 100 (QQQ) is technically overbought. The 9-day RSI is now above 70. Bollinger’s B percentage just broke above 100. The MACD has reached an extreme. The shares are trading at a large premium to the 20-day moving average. Last time, these indicators all lined up the same marked a short-term top in QQQ.
The NASDAQ 100 (QQQ) strays a bit from skis on a comparative basis against the other three major indexes. The Nazzy is posting a dramatic gain of over 20% so far in 2023. Compare that to the still very respectable nearly 7.5% gain for the S&P 500 (SPY) and it’s easy to see how QQQ’s are. is adjusted relative to other stocks. in Q1. If you compare QQQ’s gains to those of IWM (Russell 2000) or DIA (Dow Jones Industrials), the outperformance is even more staggering.
Certainly, some outperformance of the NASDAQ 100 is justified given that it was the worst performing index of the big four in 2022. This outperformance, however, is now reaching its extreme. Expect QQQ to underperform over the next few months as the comparative spread converges towards the more traditional relationship.
Two stocks, Microsoft (MSFT) and Apple (AAPL), account for more than 25% of the NASDAQ 100 Index weighting. They also include more than 13% of the S&P 500-the first time two stocks were so powerful since IBM and AT&T in the late 1970s. Plus, they’re the only stocks with a market capitalization of over $2 trillion.
To a large extent, as these two stocks are doing, so are the NASDAQ 100 and stocks in general. Examining the valuations of these two mega cap names will provide a good overview of valuations generally for QQQ.
The most weighted price-to-sales ratio for Microsoft (MSFT) is now well above 10 and the highest multiple since August 2022, when the QQQ peaked.
Number two, Apple paints a similar picture.
The price/earnings ratio in MSFT is even more extreme, now at a higher level than at the previous QQQ price peak. All this even with a sharp increase in interest rates during this period, which should cause multiples to contract.
Option prices are cheap. The NASDAQ 100 is technically overbought and fundamentally overvalued. The combination of these two statements means that buying put options now on QQQ is much cheaper and much more sensible than at any time this year. All we need is for the market to return to some semblance of profit sensitivity on a bet.
What to do next?
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All my wishes!
QQQ stock closed at $320.93 on Friday, up $5.25 (+1.66%). Year-to-date, QQQ has gained 20.71%, compared to a 7.46% rise in the benchmark S&P 500 over the same period.
About the Author: Tim Biggam
Tim spent 13 years as Chief Options Strategist at Man Securities in Chicago, 4 years as Chief Options Strategist at ThinkorSwim and 3 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 “Morning Trade Live” network. His primary passion is to make the complex world of options more understandable and therefore more useful to the everyday trader. Tim is the editor of POWR Options newsletter. Learn more about Tim’s journey, as well as links to his most recent articles.