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Hedging Your Tech-Heavy Portfolio Into Q2 Earnings

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'Buy the rumor, sell the news' price action is playing out like clockwork today, a trend that has become increasingly apparent in this unprecedented 2021 stock market. We saw counterintuitive moves from this week's market catalysts that perfectly aligned with this buy the rumor, sell the news trading pattern.

Banks have seen some enormous beats in their Q2 reports, but the markets are pulling profits following the big run this outperforming sector has had in the past 9 months. Now I am looking to tech, which has had a significant rally since mid-May and is currently sitting at its most overbought levels since last September. If you remember, last September, the Nasdaq 100 took a nearly 15% haircut because of how overheated it got.

This pattern of buying the rumor of great earnings and selling the news once they come to fruition, combined with these overbought levels, makes me quite nervous about my tech-heavy portfolio. I am buying put protection in the Nasdaq 100 tracking QQQ (QQQ - Free Report) ETF to hedge against any downside move amid this highly uncertain Q2 earnings season.

I am currently looking at August 20th expiring QQQ puts with a strike price of $355. I chose August 20th because it's a monthly contract and will be the most liquidity for next month. I decided on a $355 strike because it's a near-the-money put with excellent volume and a reasonable level of implied volatility (risk premium).

Now to figure out how many contracts you want to purchase to hedge your entire portfolio, you're going to need to do some math. It is important to understand how to fully hedge your portfolio, something you do not want to do but must be explained to understand the put positions. To do so, you would take your portfolio's value divide it by the share price of the ETF times the absolute value of delta (the correlation between the options and the underlying asset's price) times 100 (the number of shares per contract):

As I said, you don't want to fully hedge your portfolio because that effectively means you would trade sideways (assuming you are buying/selling options to reflect changes in delta). The approach I would take is to take that full hedge, divide it by 2 or 3 or even 4 and use that figure as the number of contracts to purchase.

Don't hold these things till expiration but rather scale out of them as the price moves down, and you can even buy more as the ETF's price moves up (only do this if you are willing to put on more risk). If you don't feel comfortable with options, then I would suggest you stay away.


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