Tech Stock Volatility Fears Spike: Options Market Signals Caution

Rising Tech Stock Volatility Fears Spark Protective Options Activity

Options traders are increasingly concerned about the potential for a sharp downturn in tech stocks in the coming weeks, leading them to take action to protect their portfolios from potential significant losses. This concern comes as the tech-heavy Nasdaq 100 index has seen a remarkable rally of nearly 40% since early April, largely fueled by the mega-cap tech stocks. This includes giants like NVIDIA, Meta Platforms, and Microsoft, which have seen a staggering surge of nearly 50% since their April 8th lows.

Beneath the Surface: Potential Market Weaknesses

Despite these impressive gains, there are concerns that these rallies are masking underlying weaknesses in the market. A number of potential triggers for a downturn are on the horizon, starting with the Federal Reserve's Jackson Hole symposium in just a few days and NVIDIA's upcoming earnings reports the following week. Jeff Jacobson, head of derivatives strategy at 22V Research Group, indicates that traders are concerned about a repeat of the widespread sell-offs that we saw in April. And while Jacobson expects a shallow dip, they would rather prepare for the worst.

Options Speak: Increased Demand for Risk Protection

The options market behavior reveals growing anxiety about substantial declines. According to Jacobson, traders are buying "catastrophic put options" on the Invesco QQQ Trust Series 1 ETF (QQQ), which tracks the Nasdaq 100. Put options give investors the right to sell the underlying security at a specific price, providing a way to hedge against market downturns. Jacobson notes that a metric measuring the cost difference between hedging against large declines versus hedging against small declines has risen to its highest level in nearly three years.

Historical Parallels and Warnings

Torsten Slok, chief economist at Apollo Global Management, highlights the striking similarities between the current tech stock movement and the dot-com bubble of the late 1990s, adding to the concerns about a potential bubble. Michael Hartnett, chief investment strategist at Bank of America, has also been warning since last December that risky assets are forming a bubble, and anticipates a decline in the U.S. stock market following the Federal Reserve's Jackson Hole symposium.

Potential Triggers for a Downturn

Jacobson points to "multiple factors" that could trigger a sharp downturn in big tech stocks. He cites the example of Salesforce's stock falling 27% this year due to market concerns about the impact of artificial intelligence on software companies. Additionally, any tariff-driven inflationary pressures that force the Federal Reserve to reduce the interest rate cuts already priced into the market could put a lid on the big tech stock rally.

A Shift in Market Leadership?

Jacobson suggests that capital could rotate out of the big tech stocks and into other lagging sectors. He cautions that NVIDIA's upcoming earnings reports could lead to a "buy the rumor, sell the news" scenario. Even the Jackson Hole symposium could trigger a "buy the rumor, sell the news" sell-off.

Suggested Trading Strategies

To bet on a correction in the Nasdaq 100, Jacobson suggests various trading strategies, including buying put ratio spreads – which involves selling put options to protect against deeper declines to partially offset the cost of buying put options to protect against small declines. Specifically, Jacobson recommends traders buy October 17 expiring QQQ put options with a $570 strike price and fund that trade by selling twice the number of QQQ put options with a $515 strike price. He explains that this trade would profit if the index falls about 2% and no more than 11%. He believes the $515 level, which is the ETF's 200-day moving average, will provide support in the event of a pullback.

Diverging Opinions on Wall Street

However, not everyone on Wall Street believes that investors should be shorting the best-performing major U.S. stock index of the past decade. For example, JPMorgan Chase cross-asset strategists suggest shorting the small-cap Russell 2000 index while going long the Nasdaq 100. Nevertheless, Jacobson remains bearish on the near-term outlook for big tech stocks. "Clearly there's that possibility, right?" he asks, "There's so much concentration in these stocks, a little bit of negative news could trigger volatility." Jacobson adds that investors should be aware of the market concentration and the potential risks involved with hedging.