After what has been almost a decade of uninterrupted rises, 2022 has seen a violent reversal in fortune for the Nasdaq 100 (an Index of the biggest and primarily US listed Tech firms around the world). From a peak of 16769 in late November, the Index has reached 14438 as of 21st January of this year, a drop of nearly 14%.
Pressured by increasing expectations that the Fed, alongside most other Western Central Banks are about to both end Quantitative Easing AND being normalising interest rates higher, investors have begun the process of rotating out of “growth” names (mainly Tech) and into Value shares (which until they rose so fast, consisted largely of energy firms).
Worst Opening Month Since 2008
The NASDAQ Index is now close to its’ worst start to a year since 2008 (which itself was not exactly a banner year for investor returns).
As the chart below shows, the Index has now reached an important support zone- if this support breaks, there could be another sharp move lower ahead and already Put option buying has reached a peak not seen since the depths of the COVID market crash in March 2020.
Predictably, news headlines are full of doom, with a 20% correction from the highs, said to indicate a bear market, all but confirmed.
Former lockdown favourites (Zoom, Pelton, RobinHood and Netflix) have led the decliners, as the rate futures market is now pricing in up to 4 hikes in rates by the end of 2022, (though there is a widespread belief that the Fed will be forced by market falls to reverse course back to easing at some point in the next 2-3 years as their rate rise policy provokes a recession).
Generally, when market direction looks most certain, a reversal is imminent.
Not only is sentiment now lopsidedly bearish, but there is a Fed meeting due next week, (January 26th).
Any hint of a softening of their tapering proposals and/or a reduction in their rate hike expectations would lead to a vicious short covering rally, possibly to as high as 15500, which represents previous peaks and troughs of September and December 2021.
This week’s meeting will be an opportunity to calm investors nerves, but if they fail to do so, the search for the “strike price” of the Fed put will go on (i.e. lower prices still).
The rally that occurs next may not mark a major low point, but it should be of tradable size, but trading this market at present is high risk and stop placement is very difficult in the current environment.
It may be more prudent to use options to express a bullish view on this Index.
One way to do so would be to look at a ratio calendar spread, whereby one sells 2 calls with a strike of 15300 for February 2022 expiry and buys one call with the same strike price for March expiry.
At Friday’s pricing that puts the prices at 116.7 bid for the February call and 248.3 offered for the March call, resulting in a net cost of 14.9 points.
The trader is initially net short the Index by about 0.13 delta (or one eight of an Index future), but time decay on the Feb option means that in 11 calendar days, the position will be net neutral.
Any Index move up to 15300 on expiry will result in a net profit (with the maximum profit – around 103 points- if the Index is at 15300 on the 18th of February, whilst losses would occur if the market were to be above 15650 (around 110 index points) on that date but would incrementally rise above that Index level.
Should nothing happen up to February expiry, losses are limited to just the net premium (14.9 points), giving a maximum risk to reward ratio of 6.9:1