Options traders brace for Big Tech sell-off with ‘disaster' puts
The tech-heavy Nasdaq 100 Index is up almost 40 per cent since its early April plunge triggered by US President Donald Trump's sweeping tariffs. The rally has been propelled by big tech, with the Bloomberg Magnificent 7 Index – which contains the likes of Nvidia, Meta Platforms and Microsoft – soaring nearly 50 per cent since its Apr 8 bottom.
The concern, however, is that those gains are hiding areas of weakness lurking beneath the market's surface. And there are potential triggers for a drop coming up, from Federal Reserve's Jackson Hole symposium starting in a few days to Nvidia's earnings next week.
Traders are 'less concerned' about a 'normal run-of-the-mill pullback' and seem to be more worried about a repeat of the April sell-off, said Jeff Jacobson, head of derivative strategy at 22V Research Group, who thinks a shallower dip is more likely.
Traders are buying 'disaster' puts on the Invesco QQQ Trust Series 1 ETF, which tracks the Nasdaq 100 Index, Jacobson said. Put options give investors the right to sell the underlying security at a certain price, and are popular as a way of protecting against a market drop. A measure showing the difference between the cost of hedging against a sharp downturn and a smaller one is at an almost three-year high, Jacobson said.
Fears of a bubble are mounting, as tech stocks follow a pattern that is 'surprisingly similar' to the dot-com bubble of the late 1990s, Torsten Slok, chief economist at Apollo Management, wrote in a note to clients on Monday (Aug 18). Meanwhile, Michael Hartnett, chief investment strategist at Bank of America, has been warning of a bubble forming in risk assets since December and predicts that US stocks will drop after the Fed's Jackson Hole symposium ends on Friday.
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Myriad risks
'The market's had such a big run,' Jacobson said. 'A myriad of things' could send big tech tumbling.
For example, there are worries about the impact of artificial intelligence on software companies, which has helped push Salesforce's share price down 27 per cent this year. And the Magnificent 7 rally could come to an end if tariff-driven inflation forces the Fed to curtail interest rate cuts that the market has already priced in.
'It could be a rotation out of those the Mag Seven names into some of the other areas that have lagged,' Jacobson said. 'It could be 'sell the news' when you have Nvidia earnings in the next few weeks. We could even get a 'sell the news' out of Jackson Hole.'
The elevated put skew indicates that traders are hedging against a repeat of the tariff tantrum in April, according to Jacobson. He sees that fear as overblown. While the Nasdaq 100 sank more than 20 per cent from its Feb 9 high to its Apr 8 low, that kind of move is extremely unusual. Over the last 18 months, the average sell-off in the Nasdaq 100 has been around 12.5 per cent, Jacobson said.
To bet on a correction in the ETF, Jacobson suggests a number of trades including buying a put ratio spread, in which cost of insuring against a shallower drop is partially funded by selling insurance against a deeper, April-style plunge.
Specifically, Jacobson encourages traders to buy US$570 puts in QQQ that expire on Oct 17, and that they fund the trade by selling twice as many US$515 puts in QQQ. The trade should make money if the index falls by roughly 2 per cent and no more than 11 per cent, he said. The US$515 level is the ETF's 200-day moving average, which he believes will act as a floor in the event of a pullback.
Not everyone on Wall Street is convinced that investors should be shorting the best performing of the major US equity indexes over the last decade. JPMorgan Chase cross-asset strategists, for instance, suggest shorting the small-capitalization Russell 2000 Index and going long the Nasdaq 100.
Jacobson, however, is more pessimistic about big tech's immediate future.
'Clearly, there's a possibility, right?' he asked rhetorically. 'You have just a, such a strong concentration in these names. It wouldn't take much.' BLOOMBERG
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