Nasdaq Candy Crushed Sends Hedges to Highest Since 2008: Options

After a rally that sent technology stocks to levels approaching the Internet bubble, the air is coming out of the balloon.

Shares such as Facebook Inc., Netflix Inc., Tesla Motors Inc., Inc., Baidu Inc. and TripAdvisor Inc. are down more than 13 percent since the Nasdaq 100 Index’s 13-year high March 5. That’s pushed the cost of options on the gauge to the highest level since 2008 relative to the Standard & Poor’s 500 Index. The Nasdaq 100 has rallied 243 percent in five years.

About $80 billion has been erased from the value of the index this week as Facebook shareholders showed their displeasure over the purchase of Oculus VR Inc. and King Digital Entertainment Plc, the maker of the smartphone game “Candy Crush,” tumbled in its first two days of trading. This week’s drop in the Nasdaq 100 erased its 2014 gain and left the gauge poised for its first retreat in five quarters.

“Fast money was in these stocks, and I guess a lot of that money is coming out,” Donald Selkin, who helps manage about $3 billion as chief market strategist at National Securities Corp. in New York, said in a phone interview. “The percentage decline on the Nasdaq has been much more severe. They’ve pumped up the puts because the downside pressure has been higher.”

Stock Valuations

Stocks rebounded today as data showed household purchases rose the most in three months. The Nasdaq 100 climbed 0.2 percent to 3,571.49 at the close in New York, paring the gauge’s March slump to 3.4 percent. The index is considered a benchmark for technology stocks because its six biggest companies are Apple Inc., Google Inc., Microsoft Corp., Inc., Facebook and Qualcomm Inc.

Earlier this year, the equity gauge came within 21 percent of its 2000 peak as investors scooped up shares of fast-growing companies. The Nasdaq 100 has seen its price-earnings ratio increase 45 percent since the start of 2012 to 21, according to data compiled by Bloomberg. That’s close to the highest multiple since 2010.

Some of the biggest declines have occurred in technology companies that sold shares to the public in the last few years. Facebook is down 11 percent in March, while Yelp Inc. decreased 17 percent, Twitter Inc. declined 16 percent and Pandora Media Inc. dropped 20 percent. The Dow Jones Internet Composite Index of 40 companies has lost 8.5 percent this month.

‘Egregious Gains’

Investors concerned about deepening losses in computer and software makers are turning to options to protect the value of their holdings, according to Eric Metz, a derivatives strategist and fund manager at RiverNorth Capital Management LLC. The Chicago Board Options Exchange Volatility Index and the S&P 500 move in opposite directions about 80 percent of the time.

“The demand for Nasdaq-oriented puts and the Nasdaq-affiliated VIX is a clean hedge for some of these sectors that have had such egregious gains over the last six to 12 months,” Metz said in an interview from Chicago. He helps manages over $2 billion. “Buying VIX on the Nasdaq is a clean, concise way to protect some of those gains.”

The Chicago Board Options Exchange NDX Volatility Index, which measures the cost of options on the Nasdaq 100, climbed 4.3 percent to 18.09 this week. The CBOE Volatility Index of S&P 500 contracts dropped 3.9 percent to 14.41. Europe’s VStoxx Index fell 0.9 percent to 17.03 this week.

On the Technology Select Sector SPDR Fund, the ratio of puts to calls is near the highest level in a year. There are 137 puts for every 100 calls on the Technology Select Sector SPDR Fund, compared with a ratio of 0.62-to-1 at the beginning of the month, according to data compiled by Bloomberg.

Premium Stocks

Technology stocks are not in a bubble given the new ways of making money from increasing use of mobile devices, according to Jason Benowitz, a senior portfolio manager at Roosevelt Investment Group Inc. in New York. S&P 500 software companies will see earnings rise by 13 percent, almost double the 7.3 percent growth for the overall market, analysts’ estimates compiled by Bloomberg show.

“Companies that can grow much faster than the economy or the S&P ought to maintain a premium,” Benowitz, who helps oversee $4.7 billion at Roosevelt Investment in New York, said in a phone interview. “I expect strong results, certainly from Facebook, which we own, and some of the other growth companies.”

Even after the decline this week, Facebook shares are still up 12 percent in 2014. Investors are paying up for surging profits at the operator of the world’s biggest social network, pushing its price-to-earnings ratio to 103.

ETF Flows

About $770 million was withdrawn from technology exchange-traded funds during the five-day period ended March 27, the second-biggest outflow among 10 industries, data compiled by Bloomberg show. For the year, about $631 million has been added to the ETFs.

Implied volatility, used to gauge the price of options, on the ETF tracking the Nasdaq 100 Index is 20.9 for three-month contracts with an exercise price 10 percent below the shares, according to data compiled by Bloomberg. The measure for calls is 13.64.

“Most of the volatility index difference for the past few days comes from Nasdaq underperformance of the S&P 500,” Philippe Trouve, a VIX options trader and director for equity derivatives at Bank of America Corp. in New York, said yesterday in an interview. “There was reversal from overbought conditions.”

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