The rally in PowerShares QQQ Trust, Series 1 (ETF) (NASDAQ:QQQ) has reached epic proportions as the tech rally moves relentlessly higher on a daily basis. Like all good things, however, it will eventually come to an end. And the end is nigh for the Nasdaq. I expect QQQ to have a meaningful pullback over the coming few weeks.
QQQ is comprised of the top 100 Nasdaq stocks, with the largest five holdings comprising nearly 40% of the index. These are the heavyweights of tech, with names like Apple Inc. (NASDAQ:AAPL), Microsoft Corporation (NASDAQ:MSFT), Amazon.com, Inc. (NASDAQ:AMZN), Facebook Inc (NASDAQ:FB) and Alphabet Inc (NASDAQ:GOOGL).
While the valuations given to AMZN and FB have always been rich (or perhaps absurd), now even Apple, the biggest component of the QQQ, is no longer the value stock is was a year ago. AAPL currently sports a price-to-earnings multiple over 16, by far the highest over the past year.
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Year-to-date, the QQQ is up a stunning 10%. To put that in a different context, if the Q’s maintained the torrid pace of the rally, it would end up the year with a gain of 97.8%. Of the 34 trading days this year, QQQ has been up 27 days and down only seven.
In February, there have been 12 up days and only two down days, with the two down days only being 11 cents and 4 cents.
Certainly might be difficult to sustain that type of pace going forward.
The Q’s are by far the most overbought in the past two years with a 14-day RSI reading over 85. Readings at these extremes are rare indeed, especially for an index or ETF.
Click to Enlarge Implied volatility (IV) is priced at the lowest levels over that time frame, meaning option prices are cheap, trading at only 4%. Yesterday saw notable put trading in the QQQ, with an inordinate amount of put selling. This type of action is usually indicative of tops in the underlying shares.
So with the Q’s at grossly overbought levels and with option prices dirt cheap, taking a bearish position using long put options makes a lot of sense.
QQQ Trade Idea
Buy QQQ March $130 puts at $1.50 or better.
These are the at-the-money puts and cost only 1.1% the price of the QQQ. With IV at low levels, gamma is high, meaning these options are poised to move. A mere 2% pullback over the coming few weeks would result in a doubler for these options.
Those wishing to defray some of the exposure could elect to sell shorter-term weekly options against the long traditional Mar $130 puts.
As of this writing, Tim Biggam did not hold a position in any of the aforementioned securities. Anyone interested in finding out more about option-based strategies or for a free trial of the Delta Desk Research Report can email Tim at tbiggam@deltaderivatives.com.
