Three Valid Reasons To Say "Give Puts A Chance"
The article discusses how to hedge against a decline in the stock market using VXN and QQQ puts.
We apologise to John Lennon, the Plastic Ono Band, for the title of this article on VXN/QQQ puts.
The bulls have returned to the forefront, particularly with the NASDAQ 100 stocks, and the bears are now in hibernation. It is uncertain whether the momentum will continue.
However, one thing is certain: Stock measures are getting more extreme. This warrants caution. It is worth considering whether you are looking to protect or play for potential downside.
Option strategies are more effective than just exiting or shorting stock positions in today's environment.
These are the top three reasons to buy bearish puts now, whether as portfolio protection or as a short-term trade.
The VIX is sometimes called the Fear Gauge. Most people are familiar with it. It measures the option prices in S&P 500. Many of you may not know that the NASDAQ 100 uses a similar instrument to measure implied volatilty - VXN-, or 'Vixen-. Here is the Chicago Board Options Exchange's (CBOE), definition for VXN. We will be substituting QQQ to NDX for our purposes since QQQ trades more frequently.
Cboe NASDAQ-100 Volatility Index SM SM (VXN), is a key indicator of market expectations for near-term volatility, as conveyed in NASDAQ-100(r) Index (NDX). Option prices. It is a measure of the market's expectation for 30-day volatility implied in the near-term NASDAQ 100 options. VXN is expressed in percentage points.
As stocks have rallied over the last month, VIX has seen a sharp drop in recent months. VIX closed Friday at the lowest level of the year, just as the S&P 500 rose, but not close to its yearly highs.
VXN closed Friday at a new yearly lowest level. However, the NASDAQ 100 (QQQQ), however, closed at a new yearly highest. VXN also closed at its lowest level since January 2022.
Comparing the prices of QQQ at similar pricing the last time will reveal how much the VXN drop has reduced the cost of puts. Below are the comparative option montages.
QQQ closed at 320.58 on August 25, last year. The November 18th $315 put had 85 days before expiration and was priced at $14.00. IV was just 29.
Quick forward to Friday and QQQ closed on Friday at $320.93. This is only 38 cents more than it was back in August. The expiration date for the June 30th $315 puts was 91 days away, which is a few days more than the November 18th expiration puts that expired back in August. The June 30th put was priced at $11.00 IV was just 24.
It is worth noting that the $315 put from August was slightly out of reach and traded $3.00 less than the almost identical puts currently trading.
Another way to view it is that August's puts cost 4.37% more than QQQ now, whereas they cost only 3.43%. Because IV fell from 29.04 down to 23.76. I find buying put at a lower price (and often the lowest price in quite some time) to be a good thing.
VXN can also be used to predict market trends, much in the same way as VIX. As the chart below illustrates, drops to relatively low levels of VXN nearly always coincide with short-term tops within QQQ. Is the QQQ close to a top$? The VXN suggests so.
Technically, the NASDAQ 100 (QQQ), is becoming overbought. MACD reached an extreme. The shares are trading at a significant premium to the 20 day moving average. These indicators aligned in a similar fashion last time, which marked a short-term peak in QQQ.
Comparatively to the three other major indices, NASDAQ 100 (QQQQ) is a bit higher than the rest. The Nazzy has seen a remarkable increase of more than 20% in 2023. Comparing that to the nearly 7.5% gain for the S&P 500 SPY, it's easy to see how QQQ has rallied against other stocks in Q1. The outperformance of QQQ is even more impressive when compared to the gains of DIA (Dow Jones Industrials), or IWM (Russell 2000).
The NASDAQ 100 was the worst performing index among the big four in 2022. There is no doubt that it has outperformed. This outperformance is becoming extreme. QQQ will be a weak performer in the next months as the relative spread moves back towards the traditional relationship.
Microsoft (MSFT), and Apple (AAPL) account for more than 25% of the NASDAQ 100 Index weighting. They also make up over 13% of S&P 500 - the first time that two stocks have been this powerful since IBM/AT&T in late 1970s. They are also the only stocks to have a market capitalization of at least $2 trillion.
These two stocks are largely responsible for the decline of the NASDAQ 100 as well as stocks in general. These two mega-cap names can be used to get a good idea of the QQQ's valuations.
The price/sales ratio for top-weighted Microsoft (MSFT), is back at well over 10, and the highest multiple since August 2022, when the QQQ peaked.
Number two Apple paints an identical picture.
The MSFT price/earnings ratio is now even higher than at the QQQ peak in QQQ. This is despite the fact that interest rates have risen sharply over this time period, which should cause multiples of these to contract.
Option prices are very cheap. The NASDAQ 100 is both technically overpriced and fundamentally overvalued. These two statements combined mean that purchasing QQQ puts is cheaper and more sensible now than ever before this year. We just need the market to regain some sense of profitability on a put-play.
What should you do next?
Our latest presentation, How to Trade Options With the POWR Ratings, will help you find the best options trades in today's market. We will show you how to find top options trades while minimising risk.
QQQ shares closed Friday at $320.93, an increase of $5.25 (+1.66%). QQQ shares have gained 20.71% year-to-date compared to a 7.46% increase in benchmark S&P 500 index over the same period.
About the Author: Tim Biggam
Tim was Chief Options Strategist for Man Securities in Chicago for 13 years, and 4 years as the Lead Options Strategist of ThinkorSwim. He also spent 3 years as Market Maker at First Options in Chicago. He is a regular guest on Bloomberg TV, and a contributor to the TD Ameritrade Network's "Morning Trade Live". His passion is to simplify the complicated world of options and make it more accessible to everyday traders. Tim is the newsletter's editor. Find out more about Tim and his background.