In the Money: Short Big Tech Early

Editor's note: With this column we introduce Jay Shartsis, who will pen a new column on the options market. Shartsis is director of options trading for R.F. Lafferty, where he has authored his market letter Shartsis on Charts since 1979. Shartsis has also written The Striking Price column many times in Barron's. Enjoy Jay's column and, as always, tell us what you think!

---

Wednesday's powerful rally continued a recovery that began last week. News of a U.S. military strike or the capture of bin Laden would bring about a further euphoric binge. In that scenario, I would be a seller and a short-seller of stocks that are very extended and have been subject to a great deal of call -buying.

Some stocks that have been experiencing a lot of call-buying and may thus be considered decent short candidates include Microsoft(MSFT Quote), Nokia(NOK Quote) and AT&T(T Quote). Another stock that has been up sharply and is a beneficiary of falling interest rates is Fannie Mae (FNM Quote). If interest rate reductions are finished for now, this one could be ready to come down. Interestingly, it fell Wednesday, perhaps a harbinger. (I am short out-of-the-money calls in Fannie Mae.)

Through Wednesday, the market has had a pretty sharp rally from the Sept. 21 lows, with the S&P 500 up about 100 points, or a little more than 10%. The Nasdaq 100 was not as good; until Wednesday, in fact, it was revealing a negative divergence with the Nasdaq Composite, unable to approach its highs of a week ago, while the S&P is way over its comparable peak.

A window on the over-the-counter (OTC) weakness is exposed if we examine the Nasdaq 100 Trust, or QQQ (QQQ Quote), option situation. The largest concentration of open interest continues to stubbornly reside in a call strike, specifically the October 30 strike with 104,335 contracts outstanding.

In contrast, the biggest put concentration is in the October 27 series, totaling only 57,425 contracts. For the bulls this would be much better reversed, with a big put interest to represent a "wall of worry" to climb. So we will probably get a pullback soon, perhaps even a test of the lows.

Considering the extreme readings recorded by many indicators post-World Trade Center disaster, that test should be successful. For instance, the 21-day average of the put/call ratio for all NYSE stocks hit a record -- that is, a record for put-buying. The VIX, the Chicago Board Options Exchange's volatility index for the S&P 100, reached the 60 level, and the VXN (that's the VIX for the Nasdaq) reached 98, so there's quite a lot of fear there, too.

To put these numbers into perspective, the VIX was in the lower 20s in early August and the VXN was as low as 43 in July. My "mirror-image" OEX, or S&P 100 index, put/call ratio saw fear translate into out-of-the-money OEX puts priced 10 times that of out-of-the-money calls. The WTC catastrophe also compressed a great deal of selling into the week ending Sept. 21, so much so that those lows are probably good for several months. It is likely that a good deal of that selling was due to margin calls -- which leave the market in a strengthened technical condition because those sellers have now been eliminated.