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Trading Options QQQ for a Near-Term Bounce

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Fear has taken hold of this market, with the Nasdaq 100, the primary market directing index since the pandemic hit, falling off a precipitous cliff on the Thursday following the most hawkish FOMC decision in recent history (5/5).

Fed Chair Powell managed to catalyze a relief rally in his post-meeting press conference Wednesday afternoon (5/4) with market-soothing words of economic buoyancy amid this monetary tightening cycle, but after sleeping on, it would appear that investors decided that a “soft-landing” wasn’t as plausible as Jay Powell made it sound.

This big tech-powered index is now back in bear market territory after just a couple of regular trading hours above that -20% threshold. However, the Nasdaq 100 managed to find much-needed support in the session’s final minutes after retesting its 52-week lows.

The stock market is whiplashing as the crazy bond market action induces panic across asset classes. However, with critical support levels continuing to hold, this fear-fueled market sell-off is looking increasingly like a buying opportunity.

Let’s dive into the primary fear drivers and a trading idea to take advantage of the overcorrection.

The Fear

The US public equity markets are at an apex point of uncertainty following the Fed’s most hawkish monetary decision in decades in its post-May meeting decision. The Central Bank implemented the anticipated 50-bps rate hike (largest single meeting hike since 2000) as well as the previously outlined “aggressive” balance sheet reduction plan (quantitative tightening or QT).

The scariest part of the Fed’s decision (to credit traders primarily) appears to be the anticipated plunge in Treasury market liquidity once the Central balance sheet asset roll-off plan begins June 1 at a $47.5 billion monthly pace only to double to $95 billion by September – just the second time in history that the Fed has implemented QT and the first time it’s been done in combination with a rate increase.

Jay Powell’s nullification of the possibility for a 75-bps Fed Funds hike in the upcoming meetings fueled a risk-on rocket higher in the afternoon that followed the FOMC’s May meeting. However, bulls couldn’t hold the Nasdaq 100 above that bear market threshold, as sellers came in with volume in the subsequent Thursday session (5/5) to test the validity of any sort of real risk-on breakout amid the market contraction we’ve been experiencing since the year began.

The public market’s overt skepticism about Jay Powell and his band of market accommodating Fed Official’s ability to execute a “soft-landing” (moderating demand, primarily in the labor market, with sequential rate increase & QT while maintaining economic buoyancy) was exhibited after investors had a night to sleep on the implications of this incredibly hawkish Fed policy shift (despite its alignment with expectations).

Fear always spells opportunity, and this market is ripe with it as the VIX (aka the market’s fear index) soared back up into the 30-handle (any reading above 20 indicates a highly volatile trading environment). In the 8 years that preceded the crazy pandemic-driven market action, the VIX had only closed above 30 on just three occasions and never for more than a few sessions.

I have no doubt that Powell meant it when he said he sees a good chance for a “soft landing” with an incredibly healthy economic backdrop to support the Fed’s aggressive monetary tightening

The Nasdaq 100 has come down to its lowest levels in over 13 months, despite top and bottom-line results and outlooks for this growth-oriented index’s holdings having grown in double-digits over that time horizon.

A recession is undoubtedly getting priced into this market, but the market isn’t correctly positioning for what a new economy recession would look like.

The only businesses that will continue to drive secular growth amid an economic slowdown are digital innovators who’ve been overly punished by increasingly hawkish expectations. Now that Jerome has let the monetary genie out of the bottle (unveiling the Fed’s flexible plan for the next 6 months), I’m looking to buy up the best-positioned tech business, and QQQ is an excellent way to trade this overcorrected environment.

The Trade

I’ve got my eye on a relatively low-risk option spread in Invesco’s Nasdaq 100-tracking ETF (QQQ - Free Report) option chain that can be utilized to profit off this fear-fueled sell-off with an upfront credit. I use QQQ to trade the Nasdaq 100 due to its incredibly liquid contracts across strike prices and expirations.

I’m taking advantage of a bullish mid-June expiration option spread that will allow me to generate returns from a market rebound and declining volatility while limiting my downside risk.  

This 3-Legged QQQ trade involves a bullish June 17 put spread (selling/writing an in-the-money put while buying an out-of-the-money contract), which will generate the credit we will use to purchase a naked call contract.

QQQ June 17 Bullish Option Spread:

Buy $310 Put @ $13.00

Sell/Write $320 Put @ $17.50

Buy $340 Call @ $3.75

Upfront trade credit (cost): ($1,250) + $1,700 + (400) = $75

P.S. remember that each contract is quoted at the per-share rate but represents 100 shares of the underlying security.

Below is the P&L breakdown of this trade made on Options Profit Calculator’s website. I’m using the range of $275 to $400 due to the strong support around $300, a support level the bulls will undoubtedly show up with volume at, while $408 represents QQQ’s high last November. I deem that $400 would likely be the highest QQQ could rally to (28% above the $313 we closed this Thursday session at) over the next 1.5 months.

Option Profit Calculator
Image Source: Option Profit Calculator

As of writing this (after close on Thursday 5/5), I was able to execute this trade for a $75 credit, but option prices are moving at light speed, and you will likely not be looking at the same prices that I have in front of me now. What you want to focus on when setting up your limit orders for this spread is to ensure that credit from selling the in-the-money $320 June put contract offsets the costs of the out-of-the-money put & call contracts, resulting in no upfront cost (and preferably a credit).

The Levels to Watch

If this week truly did mark the bottom of QQQ’s dizzying 24% decline from its highs 6 months ago, then the fib-derived price targets where I’ll be scaling out of this trade would include $350, $370, and $400 (shown in QQ’s chart below).

Image Source: TradingView

The Fibonacci-retracement over the QQQ above is drawn from the highs in early March to the lows 11 days later. You can see that this specific technical overlay has held incredibly well in recent months, having delineated this leading ETF’s peak at the end of March (161.8% golden ratio retracement at $370), then putting a bottom in this week’s precarious action (-23.6% retracement at $309.75).

Final Thoughts

The public markets tend to overdo momentum-led moves both to the upside (seen in the 2-year surge up to the peak at the end of 2021) and the downside (e.g., where we sit today). Euphoria and panic are the exaggerated emotions compelling this type of hyperbolic price action, both of which present unique trading opportunities.

I would not hesitate to pull the trigger on this 1.5-month bullish option play (assuming you are comfortable trading options), as I suspect we’ll see a friendly bounce in the days ahead. This is not to say that I’m calling a singular momentous bottom (unknowable with the unparalleled level of economic/market uncertainty). However, I am calling for a bounce here after two failed attempts to break below $309.75, which is why trading options are the best way to play this crazy market.

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