Momentum keeps going until it doesn’t. May sound simple, but it has simply been the best trading strategy over the past two weeks.
This is especially true for the momentum poster child stocks like Amazon.com, Inc.(NASDAQ:AMZN), Nvidia Corporation (NASDAQ:NVDA) and even old stalwart PowerShares QQQ Trust, Series 1 (ETF) (NASDAQ:QQQ).
Higher prices beget higher prices, until the prices are lower. Then the momentum ends. Yesterday, these three stocks finally saw lower closing prices after massive eight-day gains.
With another downleg more likely than not, let’s look at an aggressive and conservative option trade to position for a pullback on each of these three names.
Tech Stock Options: Amazon (AMZN)
Click to Enlarge Shares of AMZN rallied nearly $52 points from the recent lows on May 17, rising for eight straight days for a total gain of nearly 5.5%. Amazon breached the $1,000 level on Tuesday and again Wednesday before faltering and closing lower.
This type of reversal pattern, with a stock making a new high only to close lower is many times indicative of a short-term top. Especially considering AMZN stock trades at its richest price-earnings multiple of the past three months — 187.
With that in mind, here are two differently styled trades depending on how much risk you’re willing to take:
Conservative Call Credit Spread: Sell AMZN June $1020/$1022.50 call spread for 55 cent credit.
Aggressive Put Purchase: Buy AMZN June $980 put for $7.34.
The call credit spread yields 22% on money risked, while the put buy only requires AMZN stock to fall 1.9% to break even.
Tech Stock Options: Nvidia (NVDA)
Click to Enlarge While NVDA stock has been a comparative piker and rallied only six of the past eight days, the $17.15 point gain from May 17 to May 30 actually equates to a massive 13.42% gain over that two-week period.
Like Amazon, shares of Nvidia rallied to a new high Wednesday, but reversed course to close lower. Once again, much of the rally was predicated on a huge multiple expansion. NVDA now trades at by far the highest P/E (over 48) over the past three months.
Here are two bearish trades on NVDA to take advantage of the loss of momentum:
Conservative Call Spread: Sell NVDA June $152.50/$155 call spread for 45 cents net credit.
Aggressive Put Purchase: Buy NVDA June $142 puts for $3.29.
The former trade yields 18% on money risked, while the latter requires NVDA stock to fall 3% from today’s price of $143 to break even. Anything lower than that is pure profit.
Tech Stock Options: PowerShares QQQ (QQQ)
Click to Enlarge Representing a diversified basket of the top 100 Nasdaq stocks, QQQ had moved higher every day from May 17 to May 30, with the total move equalling 3.89%, pretty spectacular for a broad-based exchange-traded fund. However, QQQ finally dropped nominally Wednesday.
And drop it did, which is all the momentum trading algos need to see to switch to the sell side. Like both Amazon and Nvidia, QQQ rallied to new all-time highs only to reverse course and close in the red for the day. Valuation is also at an extreme, having risen some 27% over the past year.
With more bearishness to come, consider the following:
Conservative Call Spread: Sell QQQ June $143/$145 call spread for 40 cents net credit
Aggressive Put Purchase: Buy QQQ June $140 puts for 87 cents
Taking a short position on valuation alone can prove to be disastrous, especially in this momentum-driven market. By overlaying technical analysis as an additional screen, traders can many times identify crucial turning points when it becomes more likely that the trend has indeed come to an end.
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.
