Another Way to Hedge Tech Stock Volatility

At a Glance

  • Nasdaq-100 futures offer multiple ways to protect against sudden swings when tech earnings are reported.
  • In May, CME Group will launch a micro Nasdaq contract for retail traders

When bitcoin hit its high in December 2017, its total market cap was approximately $420 billion. By contrast when the five stocks in the FAANG plus MSFT hit their highs back in September/October 2018, their combined market cap was closing in on $5 trillion. To put that number in perspective, it was roughly 17-18 percent of the market cap of the entire U.S. stock market.

There was some concern that bitcoin was a bubble and could have resonating economic impact once it popped. It did not. Oddly, there seemed to be less concern when FAANG+M was at the high. I’m not sure why as these six stocks have a tendency to trade with a reasonably high correlation.

The Tech Week Earnings Entree

The market was and still is historically top heavy.  FAANG+M still makes up almost 44 percent of the entire Nasdaq 100.  As we would expect, these stocks are also some of the most widely held by the public.

Not coincidentally earnings season has evolved over the years to a point where most everything seems like an appetizer building up to the tech week entree.  This has created a binary event with ramifications for both the casual investor and the active trader.  The problem now becomes how to prepare for the added risk associated with being a holder of these names.  Fortunately, there’s a way.

Mitigating Risk

Futures markets, at their core, are a risk mitigation asset.  The history of futures began with farmers hedging crop risk and has evolved to include banks and hedge funds hedging fluctuations in rates, currency exchange and equities. These same assets can also provide utility to retail traders and investors.  The E-mini Nasdaq 100 contract mirrors the Nasdaq 100 index which means its makeup consists of 42 percent FAANG+M.  An investor or trader who has heavy exposure to FAANG+M basically has three options going into the tech week that begins April 24.

1)Do nothing and face the risk head on.

2)Rebalance their tech exposure. This method would be effective but may trigger unwanted tax consequences.

3) Use futures or options on futures to hedge the risk of tech week.

Here are examples of how this could work:

Google reports on April 22, Facebook on April 24, Amazon and Microsoft report on April 25 and Apple reports on April 30.  If someone believed that they had an unacceptable level of exposure to tech going into this event and wanted to lighten that exposure without triggering a tax event they could buy a week 1 May 6950-6850 put spread for approximately 25 tics.

This trade would risk $500 to make a potential $1500 per one contract. This option would expire on May 3 so would encompass all the major tech earnings.  With this trade you would be hedging $140,000 of stock against losses between 2.7 percent down to 3.5 percent. This particular option won’t be listed and available to trade until the end of March but I estimated the price based on a similar duration option and an underlying price of Nasdaq price of 7100.

Another way to hedge risk would be to be short the E-mini Nasdaq futures contract through the volatility created by the event. The advantage of this would be that you were protected dollar for dollar on the downside up to $140,000 per contract.

Micro Futures Coming

The E-mini Nasdaq also trades with great liquidity around the clock. This can be useful during earnings seasons because most of the releases are in off market hours.  In May CME Group will launch the Micro E-mini Nasdaq 100 contract which will be one-tenth the size of the standard E-mini Nasdaq-100 . The smaller size will open hedge possibilities and trading flexibility to smaller investors and traders.

In my mind these type of trades helps me sleep easier and not have to scramble in the aftermath of a surprise earnings report.

Learn more about trader tools and resources for E-mini Nasdaq 100 futures.

Jim Iuorio is managing director of TJM Institutional Services and a veteran futures and options trader. Jim has spent his career brokering futures and options trades for large institutional clients in equity indexes, interest rate products, commodities and foreign exchange. His recommendations to clients blend macro-economic themes with technical analysis.

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