Although the "Big Seven of U.S. Stocks" are still reaching record highs, cracks are beginning to appear in AI trading. Concerns about revenue growth for OpenAI have hit "New Cloud" stocks, and chip stocks were also sold off on Tuesday due to fears of competition from China.

Coupled with the Federal Reserve's first interest rate hike in September since 2023, and the market expecting another hike to follow shortly thereafter, this index, which is dominated by tech stocks, faces considerable resistance.

These pressures do exist, but option traders have been prepared for greater fluctuations in recent periods, and the actual volatility on NASDAQ has not reached that level.

An indicator that measures the volatility priced in by options traders – the QQQ Implied Volatility Index (VIX) – closed at nearly 20.7% on Monday. This makes the volatility of the Nasdaq 100 index comparable to that of small-cap stocks. The Russell 2000 usually has a higher IVx than the Nasdaq 100, but currently, both the QQQ and the iShares of the Russell 2000 are actually around 20.7%, while the ETF of the S&P 500 is 15%. Moreover, for 29 consecutive trading days, the IVx of the QQQ has been at least 3 percentage points higher than the actual volatility realized by that index.

In other words, every day since the beginning of September, the volatility reflected in option pricing has been greater than the actual volatility that ultimately occurred with QQQ. The selling pressure this week has not yet managed to close this gap.

This gap is where the opportunity lies.

When the market is falling, but the actual volatility is less than what the options expect, selling the option premium during this weakening period allows traders to set the strike price below the market level that has already dropped, while also receiving a higher price for it.

This transaction

Based on the closing price on Monday, I sold a put spread with expiration on November 13th, with strike prices of 720/710, and received a premium of approximately $1.81.

This is a trade that is biased towards bullish to neutral, in line with the trend of QQQ since this autumn. Even after this week's pullback, QQQ has still risen by about 5% since early September and reached a record high just a week ago. This trade does not require a complete reversal of the pullback; it only needs to maintain a controllable downward trend before November 13th—or before it is actively managed. As long as QQQ remains above $720 before November 13th, this trade can achieve a maximum profit of $181. The $720 put option is located slightly below the 50-day moving average of $726, while the $710 put option is slightly below the lower edge of the market's expected range of volatility, around $713. The break-even point is $718.19, which is about 3.7% lower than the closing price on Monday, meaning that even if there is further pullback during the earnings season, this trade still has room for improvement.

The reason for choosing the weekly options for the week of November 13th is to avoid NVIDIA's financial report, which is expected to be released around November 18th. The QQQ options have sufficient liquidity, so their weekly options can be used for this transaction.

If at expiration, QQQ closes below $710, which is about a 4.8% decrease from the current level, the maximum loss would be $819. The premium collected is somewhat modest, but it is a price to pay for a wider buffer zone: the theoretical probability of profit on this trade is 70%, while the theoretical probability of achieving half of the maximum profit is 80%. If at expiration, QQQ closes between $710 and $720, the sold put option may be exercised, resulting in an obligation to buy 100 shares at $720 per lot. After deducting the premium, the actual holding cost would be approximately $718.19, which is about 5.5% lower than the historical high. QQQ last closed below $720 on September 17th. Given this exposure, investors may consider closing the position before expiration or rolling it over, rather than holding until settlement.

The biggest risk comes from the schedule: On Wednesday, CPI will be announced. This week, there are also financial reports from bank stocks and TSMC. On October 28th, Microsoft and Alphabet will release their earnings, and on the same day, there will be a Federal Reserve interest rate decision as well.

Nasdaq is under pressure, but its fluctuations have not yet exceeded the pricing in the options market. This transaction involved selling option premiums amidst this weakness, while also leaving room for the market to weaken further slightly.

Disclosure:Spina holds this trading position.

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