Don't know if this was posted already - QQQ puts
Option contract benefits from 'Q' drop
By Thom Calandra, CBS.MarketWatch.com
Last Update: 10:56 AM ET Oct 25, 2002
SAN FRANCISCO (CBS.MW) - Short of selling everything, how can investors prepare for the
stock-market meltdown that is inevitable in coming months?
I asked Christopher Johnson at Schaeffer's Investment Research that question. Johnson, senior
quantitative analyst, has a keen sense of what can give skeptics of the October stock-market rally a
chance to make money. His research, along with the wary market approach of his boss, Bernie
Schaeffer, relies heavily on investor sentiment and options contracts on stock indexes such as the
Nasdaq 100 Trust (QQQ).
"In the market's current position it would be wise for options traders to position themselves with the
recent short-term trends in the market in mind," Johnson says.
"In order to do this, I would consider the QQQ January $26 puts (QAV=MZ) as a reasonably
attractive position for someone who feels that the short-term trend will be likely to reverse back to the
longer-term trend." Stocks have been dropping, with interludes like the one this month, for almost three
years.
The January 26 puts essentially are a bet the QQQ, which
represents the Nasdaq 100 Index of overpriced companies, will close
below $26 by the third Friday in January. The QQQ is an
exchange-traded fund that trades just like a stock. Others that
represent averages include the Dow Jones-member Diamonds (DIA)
and the S&P 500-member Spyders (SPY).
"This particular option had an implied volatility of 41 percent as of
yesterday's close," he said. Johnson, who unlike most professionals
sees no imminent end to the three-year down market in stocks, relies
on volatility indicators such as the CBOE Market Volatility Index (VIX),
which reflects the S&P 100 Index, and the CBOE Nasdaq Volatility Index (VXN). The so-called fear
indexes have been relatively tame this month, indicating to Johnson and his team that laid-back
investors have some nasty market surprises ahead.
"Comparing this to the three-month historical volatility of the QQQ shares, currently at 44 percent,
reveals that this option is fairly valued," Johnson says about the January $26 puts. "In addition to its
value, this option will give investors a little breathing room should the QQQ shares move higher -- as it
is currently $1.40 in-the-money (as of Thursday)." On Friday morning, the QQQ shares were selling
for $23.80.
Johnson says the delta of the option contract is negative-0.56, meaning that all other things constant,
the price of the option will increase by 56 cents for every $1 decline in QQQ shares. So, if the QQQs
get crushed and fall to, say, $18 by the third week of January, the put contract should be worth $6.10
or so. That's a double from the current level.
The QAV MZ contract was selling for $2.95 Friday morning. When I first talked to Johnson, it was
selling for $2.80.
Of course, buying such a put contract would place an investor
squarely in the path of the 80 percent of market technicians, Wall
Street strategists and even economists who already have named
October 2002 as the turning point for the three-year decline in U.S.
stocks.
Here is what Steven Hochberg, chief market analyst at Elliott Wave
International and a long-time student of investor psychology, has to
say.
"I thought the release of the latest Investors Intelligence Advisors'
Sentiment Survey was telling," says Hochberg. "Last week (before the big rally), the bulls threw in the
towel and dropped to an eight-year low at 28.4 percent (vs. 43.2 percent bears). Now, just one week
later, the whole sentiment picture flipped, as nearly everyone has jumped on this rally as the real
thing."
Hochberg, whose views on the coming market meltdown are in line with those of his boss, Robert
Prechter Jr., says the bull-bear debate reveals a lot about investor psychology. "Bulls quickly pushed
back above the bears this week, 38.9 percent vs. 35.6 percent. In 1994-1995, there was a streak of
45 weeks where there were more bears than bulls. Now that was a low. This low is nothing."
Hochberg says there are "just too many people who are trying to call
a bottom. I think it's interesting how so many experts eschew market
timing, yet they are the ones who are out front in trying to time a
low," he says from his Georgia office. "This is a bear market rally and
once it exhausts itself, it will be down again."
For more on Hochberg's trigger points for an S&P 500 decline, see
Counter-trenders stick to forecast of market deflation.
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