New lows in QQQ will likely be needed for new highs in VXN and a new buy signal.
There is an agreement between a three-year-old on a family car trip and traders and investors. Both groups want to know “Are We There Yet”. Although neither three-year-olds nor dealers have much patience, the final arrival time on a family car trip is at least known in advance. The ultimate low point is only known afterwards on the stock exchange.
In my article a few weeks ago I talked about how option prices can help predict future stock prices, in this case a short-term top. It was a take on the Warren Buffett philosophy of being afraid when others are greedy. Option pricing is the epitome of this notion. When stocks rise, option prices fall and vice versa.
This is evident from the VIX which tends to correlate inversely with the S&P 500. The VXN is a comparable measure for the NASDAQ 100 stocks. Both the VIX and the VXN are a 30-day measure of option prices.
I was thinking then about how the recent lows in VXN foreshadowed a short-term high and an impending pullback for the NASDAQ 100 or QQQ. That proved to be the case when the QQQ fell 10% in recent weeks. Now the question is how low will prices go until QQQ finds some support.
Again, I will turn to using option pricing to give me an idea when the market slump becomes exaggerated. Just as the lows in VXN usually indicate a pullback, the spike to highs is usually a reliable indicator that a short-term bottom is ahead. The chart below shows the previous six times in the past year when VXN peaked to highs and then started to decline
Each instance marked a significant short-term high in the VXN and a meaningful short-term bottom in QQQ. VXN has recently flattened out. Significant new lows in QQQ may be needed for the VXN top to explode higher into the 40 area and another buy signal.
The last four peaks in the VXN all came out near the 40 area. That would certainly be a level to consider moving from bearish to bullish on the QQQ. A retest of the key support level at $290 in the QQQ would pull back just over 10% from recent highs near $325. It would also equate to just about the 11.32% average decline for the latter six sell signals. It is highly unlikely that a drop to $290 would take VXN higher as well. Probably need new lows.
All in all, QQQ has a little more to go until it finds some footing if history holds out. Important to remember that using an implied volatility based VXN methodology is more of a market timing tool for traders. The ultimate low in QQQ will depend more on traditional metrics such as valuations.
Back to the original question “Are we there yet”. The answer is no, not yet. However, if the past is any guide, option prices say it looks like we are definitely getting much closer.
What to do?
If you are looking for the best options trading for the current market, check out our latest presentation Trade options with the POWR Ratings. Here we show you how to consistently find the best option trades while minimizing risk.
If that appeals to you, and you want to learn more about this powerful new options strategy, click below to access this timely investment presentation:
All the best!
QQQ shares closed at $289.32 on Friday, down $-1.78 (-0.61%). Year-to-date, the QQQ is down -27.05%, versus the benchmark S&P 500 index’s gain of -18.22% over the same period.
About the author: Tim Biggam
Tim spent 13 years as Chief Options Strategist at Man Securities in Chicago, 4 years as Lead Options Strategist at ThinkorSwim and 3 years as Market Maker for First Options in Chicago. He appears regularly on Bloomberg TV and is a weekly contributor to the TD Ameritrade Network “Morning Trade Live”. His overriding passion is to make the complex world of options more understandable and therefore more useful to the everyday trader. Tim is the editor of the POWR options newsletter. Read more about Tim’s background, along with links to his most recent articles.