9 hours ago
Using options to hedge against a tech decline as sector becomes overbought
The technology sector has been a primary driver of the U.S. stock market's rally in recent years, propelled by optimism surrounding artificial intelligence (AI) and semiconductor demand. However, several technical indicators now suggest overbought conditions, signaling potential risks to the rally. Is it time once again to initiate some hedging strategies? Are technology stocks overbought? Technology stocks, particularly megacap firms such as Nvidia , Broadcom and Microsoft , have driven market gains in 2025. The Technology Select Sector SPDR Fund (XLK) rose 9% in May, outpacing broader indices. In the second quarter, XLK is up nearly 17%, while the S & P 500 has climbed 6.8%. Several technical indicators suggest the recent rally may be getting overextended. We'll examine what three of the most well-known short-term overbought (oversold) indicators — Bollinger Bands, RSI, and MACD — are saying now, review historical multiples and identify an options trade on XLK. Developed by John Bollinger in the 1980s, Bollinger Bands consist of three lines plotted on a price chart: a simple moving average (SMA) and two bands that represent standard deviations above and below the SMA. The standard deviation measures price volatility, so the bands widen during periods of high volatility and contract during periods of low volatility, visually representing the dispersion of prices around the mean. You can examine Bollinger Bands yourself by selecting them from the Studies drop-down menu on the CNBC website. You will observe the XLK exceeded the upper Bollinger Band recently, indicating a potentially overbought condition. Traders and investors utilize Bollinger Bands in conjunction with other indicators, such as the Relative Strength Index (RSI) or Moving Average Convergence/Divergence (MACD), to confirm signals and minimize false positives. It's a bit hard to make out, but the RSI hit the first upper line, indicating potentially overbought conditions in mid-May and again more recently around June 12. There are naturally similarities in the results that technical indicators of this type will reveal, but the MACD indicator also crossed in late May. I am not a technical analyst, but I do incorporate technical signals into a broader fundamental and macroeconomic framework to establish whether there are near-term risks or opportunities. Historical multiples are approaching the upper end of their historical range on several key metrics. In fairness, the investment in AI (CapEx), would reduce free cash flow, but this is occurring in the midst of rising risks in the Middle East. The trade Given these risks, hedging is prudent for investors with significant tech exposure, particularly those concerned about short-term volatility. The tech sector's rally, while supported by AI-driven fundamentals, faces near-term risks from overbought conditions and external pressures. Hedging can mitigate downside risk without requiring investors to exit positions entirely, preserving exposure to potential upside. Because hedging comes at a cost, one must strike a balance between acceptable risk and cost. The 150-day moving average is currently ~$226 and may serve as near-term support, so a hedge below that level that would kick in if support should fail makes sense. For example, the September 225/215 put spread costs ~$1.17 as I write this, and would pay ~7.5:1 if XLK was below the 215 short strike price as of September expiration. That would be a decline of just over 10% and roughly the level from which XLK broke out in early May — and where there is an unfilled gap: Buy 1 Sept. 19 $225 put Sell 1 Sept. 19 $215 put DISCLOSURES: None. All opinions expressed by the CNBC Pro contributors are solely their opinions and do not reflect the opinions of CNBC, NBC UNIVERSAL, their parent company or affiliates, and may have been previously disseminated by them on television, radio, internet or another medium. THE ABOVE CONTENT IS SUBJECT TO OUR TERMS AND CONDITIONS AND PRIVACY POLICY . THIS CONTENT IS PROVIDED FOR INFORMATIONAL PURPOSES ONLY AND DOES NOT CONSITUTE FINANCIAL, INVESTMENT, TAX OR LEGAL ADVICE OR A RECOMMENDATION TO BUY ANY SECURITY OR OTHER FINANCIAL ASSET. THE CONTENT IS GENERAL IN NATURE AND DOES NOT REFLECT ANY INDIVIDUAL'S UNIQUE PERSONAL CIRCUMSTANCES. THE ABOVE CONTENT MIGHT NOT BE SUITABLE FOR YOUR PARTICULAR CIRCUMSTANCES. BEFORE MAKING ANY FINANCIAL DECISIONS, YOU SHOULD STRONGLY CONSIDER SEEKING ADVICE FROM YOUR OWN FINANCIAL OR INVESTMENT ADVISOR. Click here for the full disclaimer.
