Nasdaq Shorts Pay Off, but the Largesse May Not Last

If you believe the options market, the Nasdaq is going down in flames.

So if you own a portfolio tilted heavily toward the highflying index, now may be the best time for selling call options on the Nasdaq.

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"People are just way, way too pessimistic about the Nasdaq," noted Jerry Wang, strategist with Schaeffer Investment Research in Cincinnati. TSC pointed out Monday that put-buying in the QQQ(QQQ Quote), the Nasdaq 100 unit trust, exploded for several trading days. Tuesday extended the trend: Among the most active QQQ options were the March 180 puts, in which a 10,000-contract order crossed at a price of 5 7/8 ($587.50), up 1 ($100).

As the words passed his lips, however, the Nasdaq was down nearly 100 points at midday and Monday's put-buyers are looking awfully smart.

Volatility Index Today % Change 26.61 +3.18 Source: ILX

Understand options as a land of contrarians. When a wall of worry builds up in a particular stock or index, floor traders and option pros view that as a bullish sign for that stock or index because the masses are betting in one direction. Hence, it's time to bet the opposite way.

Put/Call Ratio Today (Noon) Previous Close 0.34 0.44 Source: ILX

The statistics on QQQ trading support the widespread pessimism. "We're now talking about a security with a 4-to-1 put/call ratio," Wang explained. In other words, option investors are buying four puts for every one call on the QQQ. More signs of pessimism: December short interest in the QQQ represented more than 90% of the float (that partly explains the 2-for-1 split).

Selling calls on the QQQ would be what's known as a covered call strategy, which works if investors hold a long position in an underlying asset, such as the QQQ, and sell call options against it, hoping any premium they collect will offset a drop in the underlying asset.

It is essentially a short-term neutral position, meaning that the call-seller will benefit because the options will expire worthless unless the stock rallies in the next five weeks. Its bullishness comes in an overall desire not to sell the underlying asset because there is a belief in long-term strength.

"Index options tend to be overpriced. And you're better off selling calls on the QQQ than buying them," Wang explained.

The QQQ was lately down 5 7/8 to 193 5/8. Wang advised selling the March 210 call options, fetching 5 ($500) per contract. February 194 call options were down 1 7/8 ($187.50) to 3 7/8 ($387.50).

As always, beware that a call option carries the risk that your stock or index may be "called away." With a call-option sale, you are selling someone the right to buy your stock or index. Be prepared to part with it.

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Among other interesting option trades, State Street(STT Quote) posted an outsized trade of 510 March 75 put options, 510 contracts traded vs. the open interest of 86. Shares of the stock were up 13/16 to 27 5/16, and the puts, generally purchased as bets that a stock will fall, were up in price, 5/16 ($31.25) to 2 9/16 ($256.25).