It will likely take new lows in QQQ to make new highs in VXN- and trigger a new buy signal.
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There is a commonality between a three-year-old on a family car trip and traders and investors. Both groups want to know “Are We There Yet”. While neither three-year-olds nor dealers have much patience, on a family car trip, at least the final arrival time is known in advance. The final low is only known on the stock exchange afterwards.
In my article from a few weeks ago, I talked about how option prices can help predict future stock prices, in this case a short-term high. It was an interpretation of Warren Buffett’s philosophy of being fearful when others are greedy. Option prices are the embodiment of this notion. When stocks go up, option prices go down and vice versa.
This is evident in the VIX, which tends to be inversely correlated with the S&P 500. The VXN is a similar measure of the NASDAQ 100 stocks. Both the VIX and VXN are 30-day measures of options prices.
What I meant at the time was how the VXN’s recent lows heralded a near term high and impending pullback for the NASDAQ 100 or QQQ. That has proven to be the case as the QQQ has fallen 10% over the past few weeks. Now the question is how low will prices go until QQQ finds support.
I’ll revisit the use of option pricing to give me an indication of when market malaise might be exaggerated. Just as the lows on VXN usually indicate a pullback, the rise to the highs is usually a reliable indication that a short-term bottom may be in sight. The chart below shows the last six times over the past year when VXN surged to highs and then started going down
Each instance marked a major short-term high in the VXN and a major short-term low in the QQQ. VXN has flattened out lately. It may take meaningful new lows in QQQ to explode the VXN spike higher towards the 40 area and a new buy signal.
The last four spikes in the VXN all peaked near the 40s. That would certainly be a level to consider switching from bearish to bullish on QQQ. A retest of the major support level at $290 in QQQ would be a pullback of just over 10% from the recent highs of $325. It would also roughly match the 11.32% average drop for the last six sell signals. It is highly unlikely that a drop to $290 would also push VXN higher. Probably need new lows.
All in all, QQQ has a little more to go before it finds a footing if the story holds up. It is 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 like valuations.
Back to the original “Are we there yet” question. The answer is no, not yet. However, if history is any guide, option prices say it looks like we’re definitely getting a lot closer.
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All the best!
Tim Biggame
Publisher, POWR Options Newsletter
QQQ shares closed at $289.32 on Friday, down -$1.78 (-0.61%). Year-to-date, QQQ is down -27.05% versus a -18.22% rise in the benchmark S&P 500 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 a Market Maker for First Options in Chicago. He is a regular on Bloomberg TV and writes Morning Trade Live weekly for the TD Ameritrade Network. His overriding passion is making the complex world of options more understandable and therefore more useful for the everyday trader. Tim is the editor of the POWR Options newsletter. Find out more about Tim’s background and links to his latest articles.
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