The broader market is looking overheated and indecisive as we enter the seasonally weakest month of the year for trading, and defensive sectors are getting bought up. I am looking at some put option spreads to maximize your potential portfolio hedging value. Invesco's Nasdaq 100 tracking ETF (QQQ) October monthly options are lining up very nicely for a trading opportunity.
This put spread opportunity is aligning because of the heavy interest in this position. When assessing QQQ's October monthlies (10/15) options chain, you can see that open put options outnumber calls 2.5 to 1. Tech-heavy money managers are flooding into these put options and driving up their premium at every strike price, providing us with this unique trading opportunity. 2.5 times as many October QQQ puts held than calls, indicates that this highly uncertain market is preparing for a slide.
In this QQQ spread opportunity, I will be purchasing October 2021 380 puts for $8.14 and selling October 2021 370 puts for $5.23, resulting in a mere $291 premium for this put spread (remember that each contract represents 100 shares). So you are risking $291 to make $709, which is a very reasonable risk/reward considering the uncertainty that lies ahead.
The Market Is Getting Ahead Of Itself
This market might be getting a little over its skis with this ceaseless bull run exhibiting an average annualized return of 75% since the pandemic low. There is an unprecedented amount of sideline cash being deployed on every dip. Still, at what point do money managers come to the consensus that this market is due for a correction? A growing number of asset managers have voiced concern about an imminent market correction (10%+ decline), and I am beginning to believe this is a possibility as this bull rally looks increasingly exhausted every day.
The S&P 500 is now trading 34% above its pre-pandemic level, despite less than 5% GDP growth. Ultra-low interest rates can explain some of this deviation, but the benchmark US 10-Year yield is trading less than half a percent off its pre-COVID level. We need to ask ourselves how much growth acceleration the global lockdown's rapid digitalization provided digitally-powered enterprises, as the world experienced 10-years of digital adaptation in a matter of 10-months, and how long the Fed will keep interest rates at these low levels.
11 of the largest 13 market sectors are trading more than 10% above their pre-pandemic levels. Many of these sectors aren't expected to get back to 2019 earnings levels this year, such as financials and consumer discretionary.
Low growth utilities and fossil fuel-driven energy are the only sectors that remain below their February 2020 highs but are largely inconsequential because they are the smallest components on the S&P 500, making up only 5% combined.
The most significant contributor to the S&P 500's boundless bull rally has been technology by a mile (specifically mega-cap tech), which should come as no surprise. The Nasdaq 100, encompassing the 100 biggest and baddest market innovators, is trading 60% above its pre-COVID February highs, with the pandemic's digitalizing effect driving sales for advancing technology to levels many of these innovators didn't expect to see for years. As of now, it looks like the markets have fully priced in (if not more than) the pull-forward in demand, and this cohort is looking drained as volumes decline at overbought levels.
The Hindenburg Omen
The Hindenburg Omen, a technical indicator that signals an elevated probability of a market crash, has been reached by this precarious market. This indicator looks for an elevated number of new 52-week highs and lows that surpasses 2.2% of all securities traded that day (the number of highs cannot be more than double the number of lows), along with an upward trending 50-day moving average and negatively shifting market sentiment (indicated by the McClellan Oscillator or MCO).
This indicator generally implies that market participants are tentative and uncertain. The Hindenburg Omen almost always precedes a stock market downturn but is only about 25% accurate when it is seen.
Investors have been positioning themselves defensively as post-earnings price action commenced. These defensive investors are buying stocks in low beta sectors like health care, utilities, consumer staples, and real estate, which have led over the past week of trading. All of the previously mentioned sectors have lagged the broader market over the past 52-weeks, so it's only natural for weakness chasing money managers to rotated into these segments even if an index level correction (10%+ decline from recent highs) isn't coming.
Remember to sell out of this spread when a dip occurs (3%-5% retraction from recent highs is plenty)—no reason to hold till expiration.
It remains a stock pickers market, but few stocks would be immune to broader market pullback. Precarious market signals are popping up everywhere as we enter September, the historically weakest month for the markets. With all the self-fulfilling prophecies occurring in this evolving market, I am almost expecting to see some adverse price action this month.
That being said, I remain bullish towards equities in the medium/long-term and will not be selling out of any of my portfolio's holdings. I will hedge until uncertainty eases, and if there a broader market decline occurs, I will be a buyer.