Tech Shares at 14-Year High Send Traders Rushing to Hedge

By Inyoung Hwang  

The Nasdaq 100 Index’s highest level since the 2000 technology bubble has sent options traders rushing to buy protection.
Bearish wagers on the Powershares QQQ Trust (QQQ) cost the most since September 2012 relative to bullish ones, data compiled by Bloomberg show. The Nasdaq 100 reached a 14-year high, buoyed this year by rallies in companies from software maker Microsoft Corp. (MSFT) to social-networking site Facebook Inc. (FB)
Investors are hedging against a potential retreat after embracing technology stocks amid bets that corporate spending will pick up and new gadgets will lure consumers. More than $1.1 billion went into the Powershares QQQ fund on
Aug. 19, the most since December 2011, according to data compiled by Bloomberg. The Nasdaq 100 now trades at an almost four-year high compared with the Standard & Poor’s 500 Index.
“People have seen big gains in names like Microsoft and Intel, and they want to protect those gains, especially since they’ve seen bumps and bruises along the way,” Barry James, who helps oversee $5.5 billion as president of James Investment Research Inc. in Xenia, Ohio, said by telephone. “Tech isn’t cheap today. If we get a correction in the overall market, the sector may be more vulnerable.”

Weak Confidence

Weakening consumer confidence usually correlates with selling in technology shares, James added. A preliminary reading of the Thomson Reuters/University of Michigan index showed last week that American consumer sentiment fell this month to the lowest level since November. The gauge is at its lowest level ever versus the Nasdaq 100, according to data going back to 1985.
The technology index has advanced for the past seven days, reaching its highest level since Sept. 1, 2000. It remains 14 percent below the all-time high from March of that year, before it plunged more than 30 percent each year through 2002 as the Internet bubble burst.
This year’s 13 percent rally sent the Nasdaq 100 valuation to 23.1 times reported profits, compared with 17.8 for the S&P 500, data compiled by Bloomberg show. It’s at its highest level since September 2010 relative to the broader stocks index.

Too Far

While the Nasdaq 100 climbed, the cost of hedging also rose as investors sought to protect gains after a selloff earlier this year. Concern that Internet and biotechnology companies rallied too far spurred a 7.5 percent slump in the index from March 5 through April 11. Netflix Inc. (NFLX), whose shares almost quadrupled last year, tumbled 28 percent during that period, while Facebook sank 18 percent after more than doubling in 2013.
Contracts hedging against a 5 percent decline in QQQ, the biggest exchange-traded fund tracking technology companies, cost 4.2 points more than calls to buy, according to three-month implied-volatility data compiled by Bloomberg. The price difference increased to an almost two-year high of 4.5 points on Aug. 5.
Even as tech shares have become more expensive, bigger companies such as Hewlett-Packard Co. (HPQ) trade at attractive valuations, have high levels of cash and pay good dividends, according to Nick Skiming of Ashburton Ltd. Shares of the PC maker are valued at 11.6 times reported profit, 50 percent lower than the multiple for the Nasdaq 100, data compiled by Bloomberg show.

Improvement Signs

The PC market has shown signs of improvement this year after Hewlett-Packard reported quarterly revenue that exceeded analysts’ estimates and chipmaker Intel Corp. (INTC) forecast third-quarter sales that topped projections. Intel trades at 17.4 times earnings.
“Investors are returning to the blue chips after not being able to find the performance from the more speculative end of technology,” said Skiming, who helps manage $10 billion at Ashburton in Jersey, Channel Islands. “There’s been a focus on returning capital to shareholders through dividends and buybacks.”
Shares of Apple Inc. (AAPL), which has the highest weighting in the Nasdaq 100, surpassed a 2012 record this week as investors looked ahead to new products such as bigger-screen iPhones and a wristwatch-like device that may jump-start revenue growth. Apple is also returning $130 billion back to investors through buybacks and dividends. The stock trades at 16.2 times profit.

Earnings Estimates

Earnings at companies in the Nasdaq 100 will jump 24 percent in 2014, the fastest rate of growth since 2011, according analysts’ estimates compiled by Bloomberg. That compares with an 11 percent growth for S&P 500 stocks.
Traders prefer bearish contracts on the technology ETF to bullish ones, with 67 percent more puts outstanding than calls, data compiled by Bloomberg show.
Of the five most-owned options, four are hedging against a decline. Puts wagering on a slide to $89.63 by January had the largest open interest, followed by contracts calling for a drop to $90.63 next month.
Low levels of volatility on the Nasdaq 100 have made the cost of protection attractive to investors, according to Stephen Solaka of Belmont Capital Group. The Chicago Board Options Exchange NDX Volatility Index, measuring the cost of options on the tech gauge, has fallen 19 percent this year to 12.50. The CBOE Volatility Index, which tracks S&P 500 derivatives costs, has retreated 14 percent in 2014 to 11.76.
“You have a market near all-time highs and protection is not that expensive,” Solaka, a managing partner at the Los Angeles-based investment firm, said by phone. “Given the recent selloff and snapback, it’s not that surprising people want to lock in gains. When volatility is lower, there’s put demand.”