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How Option Prices Can Help Predict Future Stock Prices

Use a methodology based on implied volatility to better time the best time to sell the QQQ. – StockNews

I outlined some reasons last week why I thought stocks, and in particular QQQ, had finally formed a meaningful top in my last post for POWR options. One of the main reasons the NASDAQ looked tired and toppy was complacency, which was reflected in the form of option prices.

Most of you are probably very familiar with the VIX, sometimes referred to as the “fear index”. The VIX is a general measure of 30-day option prices on the S&P 500. It tends to spike when stock prices fall sharply and generally falls when stock prices rise.

VXN, or Vixen, is a similar measure of 30-day option prices using the NASDAQ 100 (QQQ) instead of the S&P 500 (SPY). Let’s see how using the VXN as a market timing tool can help call important short-term tops in the market. It’s the equivalent of Warren Buffett’s saying, “Be scared when others are greedy.”

VXN sell signals are generated when VXN pulls back at least 33% from the previous high and then reverses from the lows. Over the past 12 months, 6 such sell signals have been generated (highlighted in aqua on the chart below)

Below is the same one-year period chart of the QQQ. Note how VXN’s lows precisely match QQQ’s highs (highlighted in red).

I have put together a quick summary of VXN based sell signal methodology over the past year as shown in the table below.

Sale price Next low Gain % Gain bottom date low days
08/31/2021 379.95 352.62 27.33 7.19% 04/10/2021 34
05/11/2021 398.6 380.69 17.91 4.49% 20/12/2021 45
04/01/2022 396.47 341.4 55.07 13.89% 01/27/2022 23
02/10/2022 358.43 318.17 40.26 11.23% 03/14/2022 32
04/05/2022 361.1 291.15 69.95 19.37% 05/12/2022 37
06/08/2022 307.4 271.39 36.01 11.71% 06/16/2022 8
11.32% 29.83

The average pullback over the past six sell signals has been just over 11%. It took about a month (29.83 days on average) for the shares to find a new low after the sell signal was generated.

Equally important, sell signals were never really too early or wrong to call a short-term top. None of the previous six signals would have caused subsequent angst using the VXN methodology as a market timing tool. Indeed, only one of the signals had a minor unrealized loss after going short on the QQQ. The other five were pretty much spot on to call the summit.

Using the VXN methodology means the market will tell you when it’s time to act. This can be important because fundamental analysis and technical analysis can often be too early…which in this market environment makes it difficult to hold a losing position for too long.

This is not to say that fundamentals and other factors are not important as confirmatory indicators for taking a bearish position.

Valuations and seasonality also point to probabilities favoring a pullback.

The two largest stocks by market capitalization on the NASDAQ 100 (QQQ) are Apple (AAPL) and Microsoft (MSFT). Both hit the highest multiples on a Price/Sell basis over the past three months before dipping. Moreover, having companies with over $2 trillion in market capitalization trading at such high valuations seems extreme in itself. The additional upside seems limited at best.

The seasonality also supports the bearish argument.

In the past twelve years, September has been the only down month for QQQ. Stocks have posted gains less than half the time with an average loss of 1%. Every other month is positive for both performance and the number of positive months versus negative months.

Comparative performance also favors a bigger pullback for QQQ compared to SPY. Normally, QQQ and SPY tend to be highly correlated. Over the past few months, however, QQQ has largely outperformed SPY. Expect this correlation to re-mean with QQQ beginning to underperform to close this gap.

VXN’s comparative lows also mean that option prices on QQQ are relatively cheap. This favors the purchase of put options to take a short position at defined risk. Exactly the type of strategy we use week after week in the POWR options portfolio.

Thus, traders looking to go short in the short term would be better served by buying put options rather than short QQQ. Limited risk with potentially explosive returns. Additionally, an increase in implied volatility will also be an advantage for the long sell position.

POWR Options

What to do next?

If you’re looking for the best options trading for today’s market, you should check out our latest overview How to trade options with POWR odds. Here we show you how to consistently find the best options trades, while minimizing risk.

If this interests you and you would like to learn more about this powerful new options strategy, click below to access this timely investment overview now:

How to trade options with POWR odds

All my wishes!

Tim Biggam

Editor, POWR Options Newsletter

Shares of QQQ closed at $322.86 on Friday, down -$6.42 (-1.95%). Year-to-date, QQQ is down -18.59%, compared to a -10.46% 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 Chief Options Strategist at ThinkorSwim and 3 years as a Market Maker for First Options in Chicago. He makes regular appearances on Bloomberg TV and is a weekly contributor to the TD Ameritrade “Morning Trade Live” network. His primary passion is to make the complex world of options more understandable and therefore more useful to the everyday trader. Tim is the editor of POWR Options newsletter. Learn more about Tim’s journey, as well as links to his most recent articles.


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