The American Stock Exchange first introduced the Nasdaq 100 Unit Trust (QQQ) - Get Report in March 1999. Today, it is one of the most actively traded investment securities, with one of the most actively traded options contracts.
The Qs, as they're sometimes called, are designed to mirror the performance of the Nasdaq 100 index, or NDX, a market average made up mostly of technology companies. Therefore, the day-to-day trading of QQQ options can offer important information about whether investors expect the technology sector to rise or fall.
The QQQ is a pooled investment with shares listed for trading on the Amex, and they can be bought and sold like common stock. However, rather than representing ownership in just one company, QQQ shares represent ownership interest in the 100 stocks that make up the Nasdaq 100 index, which is dominated by large-cap tech stocks like
. In fact, the Qs are designed to equal 1/40 of the value of the Nasdaq 100 index. Therefore, investors looking to gain exposure to the technology sector can do so by purchasing QQQ shares.
Because millions of investors trade the Qs, their day-to-day options activity can help gauge the level of bullishness or bearishness on technology stocks at any given point in time. When the QQQ moves higher, it suggests that investors are bullish on technology; when it falls, it indicates that investors are turning bearish on tech stocks. In addition, when QQQ calls are more active than puts, option traders are predominantly bullish on the tech sector. However, when there's more put activity, option traders are predominantly bearish.
The QQQ put-call ratio can be used to quantify relative levels of bullish or bearish sentiment for the technology sector. The ratio is simply the number of QQQ puts divided by the number of calls traded each day. For example, on Oct. 30, the ratio was roughly 2.24, suggesting a far greater number of puts than calls. That figure, in turn, is much higher than the 30-day median QQQ put-call ratio, which is only 0.84.
Generally, studying relative levels of put and call buying with the put-call ratio is also an exercise in contrary thinking. That is, when most traders are bearish, it is time to turn bullish. However, when investors are mostly bullish, it is time to turn bearish or negative. In that respect, a clear signal emerged from the QQQ put-call ratio on Oct. 30.
It suggested that option traders were extremely bearish before the end of October and were aggressively buying puts. From a contrarian perspective, then, the put-call ratio was a reason to be bullish on the QQQ and technology stocks on that particular day. However, the strategist will also want to consider trends and the put-call ratio over the course of several days -- not isolated readings.
The QQQ Volatility Index is also a tool for gauging what's happening within the technology sector. Trading under the ticker symbol QQV, the QQQ Volatility Index was launched on Jan. 23, 2001. The index is designed to measure the implied volatility of QQQ options, where implied volatility is a measure of option premiums.
Generally, implied volatility on options will increase when options traders are predominantly bearish on an index. In other words, if traders become uncertain and apprehensive, they will aggressively buy put options to hedge portfolios and to make bearish bets, which will drive up levels of implied volatility. The QQV offers a tool for obtaining instant implied volatility information for QQQ options.
Despite evidence of growing bearishness reflected in the QQQ put-call ratio, the QQV has been falling. Indeed, as the chart below shows, the implied volatility of QQQ options has fallen to two-month lows. The low readings, in turn, do not confirm the high reading from the QQQ put-call ratio. If investors were truly bearish on tech (as the high levels of QQQ put activity suggest), implied volatility priced into QQQ options would rise. The QQV would be higher, much like it was in July.
Therefore, the current readings emerging from QQQ options trading are mixed. That, however, will change over time. When both the put-call ratio and the QQV begin to reflect high levels of bearishness, contrarians will turn more bullish on the tech sector. On the other hand, if both indicators begin to reflect high levels of bullishness, contrarians will turn bearish.
By Frederic Ruffy, senior writer and index strategist at