Two weeks of selling in the Nasdaq 100 Index, where valuations are double the rest of the market, has sent anxiety among options traders to the highest levels since the flash crash four years ago.
More than 1 million put options on an exchange-traded fund tracking the Nasdaq index changed hands on April 4 as investors sought protection during a 2.7 percent drop in the gauge. That’s the most trading in bearish contracts since May 7, 2010, the day after $862 billion was erased from the value of U.S. stocks in a matter of minutes. King Digital Entertainment Plc has slid 16 percent since going public March 26.
While the selloff has been orderly this time, technology shares are being hit as traders dump the biggest winners of the bull market. The Nasdaq 100 fell the most in two years on April 4 with declines in all but four stocks. Traders took shelter in shares such as Coca-Cola Co. and McDonald’s Corp.
“The market is preparing itself for further trouble and going to more GE instead of gee-whiz type of companies,” Matt McCormick, who helps oversee $11 billion as a portfolio manager at Cincinnati, Ohio-based Bahl & Gaynor Inc., said in a phone interview on April 4. “Their valuations are inexcusable.”
Investors have shifted money out of Internet and biotechnology stocks and favored companies with stable dividends and earnings. General Electric Co., which pays shareholders 3.4 percent, is up 1.4 percent in the past month, while Tesla Motors Inc., Facebook Inc. and Netflix Inc. slumped more than 16 percent. The Nasdaq 100 has rallied 239 percent in five years.
In Asia, Tencent Holdings Ltd. slumped to a two-month low today, and a gauge of Internet companies erased its advance for the year. European technology companies fell the most, with Alcatel-Lucent SA losing 3.5 percent and Nokia Oyj sliding 3.9 percent. The Nasdaq 100 retreated 0.9 percent at the close in New York today.
Hedge funds that invested heavily in technology shares took a beating in the first quarter as popular holdings such as Chinese Internet company Baidu Inc. fell 14 percent and online retailer Amazon.com Inc. tumbled 15 percent.
Paul Tudor Jones, Michael Novogratz and Louis Bacon, hedge-fund managers that profited last year from bets on macroeconomic trends, posted losses in the period as some of those trades turned against them.
The losses for macro managers have caused them to cut some of their bigger bets, Anthony Lawler, a money manager at he $120 billion Swiss firm GAM, wrote in a report last week.
The selloff on April 4 boosted options trading as investors looked for strategies to protect equity holdings from declines and speculate on future swings. More than 2 million contracts on the PowerShares QQQ Trust changed hands on April 4, the most since Lehman Brothers Holdings Inc. filed for bankruptcy in 2008.
“We’re still seeing a significant number of put buyers” in the QQQs, Kurt Ayling, a technology, media and telecom desk analyst at Susquehanna Financial Group LLLP, said in an April 4 phone interview. “People are still putting a lot of protection on the Nasdaq.”
About $480 million was withdrawn last week from the PowerShares QQQ Trust ETF, data compiled by Bloomberg show. The fund ranks as the fourth-largest in the U.S. with $47 billion in assets, data compiled by Bloomberg show.
The Nasdaq Composite Index trades at 32 times reported earnings of the companies in the index, compared with 17 times for the S&P 500. The 100 biggest companies in the Nasdaq gauge trade 64 percent above the S&P 500 relative to sales and 149 percent higher relative to estimated revenue, data compiled by Bloomberg show.
“It feels like maybe a large liquidation in a tech fund,” Larry Peruzzi, senior equity trader at Cabrera Capital Markets in Boston, said in an e-mail. “The move seems excessive for profit taking.”
Lurches in technology shares have become more common in the last two months as traders reassess equities that have posted annual gains of 25 percent since 2009. Losses accelerated on April 4 as the Nasdaq 100 slid 2.7 percent and a measure of biotechnology shares tumbled 4.1 percent. The Standard & Poor’s 500 Index fell 1.3 percent.
Nasdaq 100 stocks with the 10 biggest declines on April 4 had rallied an average of 134 percent in 2013, according to data compiled by Bloomberg. Among them are Micron Technology Inc., Netflix and Tesla, which saw their shares triple or quadruple last year.
Concern that the retreat will worsen has made options more expensive. The Chicago Board Options Exchange NDX Volatility Index, tracking contracts on the Nasdaq 100, jumped 11 percent on April 4 to 18.79, a three-week high.
The volatility gauge is now 35 percent higher than a similar measure for the S&P 500, the biggest gap since 2007, data compiled by Bloomberg show. That shows investors are more concerned about declines in Internet and biotechnology shares than the overall market.
The selloff last week isn’t a cause for alarm, according to BB&T Wealth Management’s Walter “Bucky” Hellwig, who said he wouldn’t be making any large changes to his stock holdings. The retreat may be a short-term reversal after the S&P 500 hit a record, he said in an April 4 phone interview from Birmingham, Alabama.
“For all the stocks that have done really well, there’s a trader that will say, ‘I want to nail down some of these profits,’” said Hellwig, a senior vice president at BB&T Wealth, which oversees $17 billion. “One day of sloppy trading isn’t going to cause us to change direction.”
Even after the drop, Tesla shares are still up 41 percent in 2014 and Micron is up 3.8 percent. The Nasdaq 100 ETF, known by its ticker QQQ, has slipped 1.8 percent this year to $86.37.
Seven of 10 most-owned options on the fund are bullish. April $89.63 calls, with a strike price 3.8 percent above the close, had the highest open interest, followed by $90.63 and $91.63 calls expiring at the same time.
Excessive valuations mean further gains in technology stocks will be harder to come by, said Sean Sun, an equity research analyst at Santa Fe, New Mexico-based Thornburg Investment Management Inc.
Amazon.com trades at 572 times reported earnings while Netflix, an Internet video-subscription service, is valued at 141. About 15 percent of the Nasdaq 100 companies have a price-earnings ratio of 35 or more, data compiled by Bloomberg show.
“These are tech stocks trading at high valuation levels already, even with the selloff,” Sun said by phone on April 4. Thornburg oversees over $90 billion. “With the selloff accelerating, sentiment has turned more negative and given that, who knows where it ends.”