Money Managers Lay Low as Dow and Nasdaq Go Separate Ways

The tale of two markets continues.

More and more investors are taking refuge in the Nasdaq and rotating out of the Dow stocks, creating a sort of river of money flowing in different directions.

Volatility Index Today % Change 28.08 +6.93 Source: ILX

That's making it harder and harder to make straight bets or hedge those bets in your portfolio with either blue-chip S&P plays or Nasdaq options alone, said Kyle Rosen with Rosen Capital Management in Los Angeles.

Put/Call Ratio Today (Noon) Previous Close 0.38 0.33 Source: ILX

Instead, he's been buying and selling different combinations of one- to two-year LEAPS on the S&P 500 index. LEAPS, or Long-Term Equity AnticiPation Securities, are options with maturities out as far as 2 1/2 years instead of the standard 90 days. That buffers his position from the recent dramatic short-term fluctuations.

"It's turned into a fool's game trying to predict which way the market's going, but there's more than one market," agreed one Philadelphia-based options trader. "The rotation out of Old Economy -- that is, the Dow -- and into New -- the Nasdaq -- is just now hitting the pension funds, the endowment funds, the slow-moving bureaucracies, which have taken months to get the approval to move their money into the technology sector."

But for Rosen, it's too risky to simply short the Dow and go long the Nasdaq. "If the Dow rallies back to 10,600 and then sticks in a range as more money moves into technology, I could get killed. The market is too segmented to make winner-take-all bets like that."

Instead, he's using what are known in the trade as "combinations," selling three SPX call options with expirations 18 months out in the future and buying four or five call options out 24 months.

"The net effect is that I profit from a move on either side. And I use the SPX because I figure it will be tugged quite a bit as the Dow and Nasdaq move in opposing directions," he said. "The SPX hopefully, will stay in a trading range."

Just for a moment, revisit the "golden oldie" SPX trade put on by Michael Schwartz of CIBC World Markets two weeks ago. Schwartz bought the out-of-the-money SPX April 1375 puts at roughly 27 and sold the April 1325 put for 17 ($1,700) at that time. Those options were lately trading at 48 1/2 ($4,850) and 38 3/4 ($3,875) respectively.

At midday, the SPX was down 26 to 1334, so Schwartz's bottom is getting a bit closer. The point of his trade was to make money on the put option he purchased, the April 1375, and for the one he sold, the April 1325, to expire worthless. So far, so good, but there are nine weeks left for him to either close the position or hang in and hope the market sits where it is.

As far as hedging, the options on the Nasdaq 100 unit trust, the QQQ (QQQ Quote), are proving too volatile.

Rosen said the options are "incredibly difficult to trade and very volatile."

The QQQ is up 3/4 to 209 1/4, and the most-actively traded options are the March 206 calls, up 2 ($200) to 13 1/2 ($1,350).

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In daily option trading, Cabletron Systems'(CS Quote) out-of-the-money calls grabbed some attention. Out-of-the-money calls, which have a strike price higher than the current share price, are useful as speculative bets on a merger or a buyout at a price higher than where the stock is trading.

With Cabletron shares up 4 1/2 to 40 1/2, the company's March 45 calls rose 1 3/16 ($118.75) to 1 1/2 ($150) on volume that surpassed the open interest of 450 contracts.

Option traders may be speculating that Cabletron may be under pressure to sell itself in the wake of Alcatel's(ALA Quote) acquisition of competitor Newbridge Networks(NN Quote).

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Also on the Nasdaq front, word on the trading floor was that the Chicago Board Options Exchange is surveying traders about splitting the NDX contract. The index itself was lately up 9.99 to a massive 4180.08.

Splitting the NDX, or any large option contract, would be done to generate heavier volume into the contract. With the Nasdaq growing in popularity, a less expensive contract could generate more interest from individual investors.

A spokesman for the exchange said he couldn't immediately comment on rumors of the split.