Signs of caution are emerging around high-flying tech shares. But that’s just making it cheaper to use options to bet on further gains in the stocks, Bank of America’s derivatives strategists say.
After scooping up tech shares for months, hedge funds dumped the group last week at the fastest pace since early August while piling into value sectors like banks, according to Goldman Sachs Group Inc.’s trading desk. In options, traders aren’t positioning for big gains in the tech sector looking six months ahead.
If a 45% rally in tech stocks since early April looks like a bubble, it probably won’t burst any time soon, say Bank of America derivatives strategists. They advise investors to play it through a six-month call spread on the Invesco QQQ Trust Series 1 ETF. Buying it now would yield profits of seven times the price paid should the group advance at least 9.4% by late March.
“When looking at today’s price action from a distributional lens and within the context of the behavior of asset bubbles over the past century, we still see further room for a potential AI bubble to inflate,” BofA derivatives strategist Arjun Goyal said. “Buying out-of-the-money QQQ call spreads with a slightly longer six-month tenor can provide an attractive cost-benefit proposition.”
The options team’s recommendation echoes that of the bank’s equity strategists. BofA’s Michael Hartnett studied 10 equity bubbles since the start of the previous century and found that these periods of extreme over-valuation produced average trough-to-peak gains of 244%. After rising around 223% from their March 2023 low, the Magnificent Seven cohort has more room to go, the bank’s strategists wrote in a note last month.
Not everyone is convinced, however. The cost of hedging against a 10% decline in the QQQ ETF has been creeping up since mid-September relative to cost of contracts hedging against a similar rally. The fund’s six-month call skew is near the flattest it’s been since 2012, according to BofA — a sign that traders don’t expect significant price moves in either direction.
For some on Wall Street, the tech trade — which earlier involved buying an index fund and letting it ride the momentum — is becoming more nuanced, with investors opting for specific stocks while shunning the broader group.
“I haven’t seen a ton of upside call buying for the indexes, where we have seen more and more on the single-stock side,” Joe Mazzola, head trading and derivatives strategist at Schwab, said by phone.
"It’s not just your typical cast of characters — yes you’re going to see the Nvidias and the Palantirs, but we’re also seeing it stretch out in some other names that have some AI sensitivity,” he said, flagging Micron Technology Inc., and Advanced Micro Devices Inc. as companies that Schwab clients are particularly bullish on.
Hedge fund manager David Einhorn was the latest to strike a cautious tone on the AI spending surge. The unprecedented amount of expenditures on artificial intelligence infrastructure may destroy vast amounts of capital, even if the technology itself proves transformative, according to the Greenlight Capital founder.
But Mazzola thinks betting on gains in the broader tech sector still makes sense. A six-month call spread on the QQQ doesn’t need a huge rally by March to make money, with a modest bounce potentially increasing the value of the QQQ $660 call contract, he said.
“When you’re teaching people options for the first time they’ll say ‘you need a 10% rally for that thing to pay off.’ No, you don’t,” Mazzola said. The tech ETF simply “has to rally enough within a quick amount of time for you to say, ‘Hey, I made 30% or 40% on this spread. Is it worth it for me to take it off? Is it worth it for me to trim?’”
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