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January started out with a very bearish tone, but markets turned around to make new all time highs with the help of Big Tech. This week, the likes of Alphabet, Microsoft, Apple, Meta and Amazon report their earnings. These market-leaders have sky-high valuations and sky-high expectations. If these tech giants disappoint in their earnings outlook, that would be enough reason for this rally to fizzle out, and Nasdaq could finally see a pullback. I’ll explore a simple way of hedging against a pullback in Nasdaq by utilizing cheap out-of-the-money put spreads on the Nasdaq-100 index. Here’s a 6-month daily chart of the Invesco QQQ Trust (QQQ) ,which closely follows Nasdaq’s price movement and can be used as a proxy to trade tech stocks. I drew areas of support which can be used as downside price targets in case the markets go into a pullback this week. The first area of support is around $411 which represents a pullback of approximately 4%. The objective of hedging is to mitigate potential losses from a stock market downturn by purchasing ‘insurance.’ This involves acknowledging the possibility of losing the ‘insurance premium’ if no downturn occurs. Such a strategy aims to safeguard a long portfolio to some extent. Should a downturn materialize, this hedge would cushion losses in the long portfolio. Conversely, if the market continues its upward trend, gains in the long portfolio should balance out the hedge’s cost. For this trade, I am looking to buy cheap OTM put spreads on the QQQ. Since the next area of support is around $411, I want my strikes to be above this area. The Trade Setup The trade structure I am using here is called a bear put spread. You may find trading platforms using other names like “put debit spread” or “long put spread,” but they all mean the same. To construct my OTM bear put spread, I need to do buy a $415 put and sell a $414 put as a single unit. Here is my exact trade setup: Bought $415 put, Feb. 9th expiry Sold $414 put, Feb. 9th expiry Cost: $15 Potential Profit: $85 I chose Feb 9 th as the expiration for this trade which is only 10 days away. I did this because this trade is designed as a hedge against disappointing tech earnings, which are all happening this week, so I don’t need a longer expiration date. Profit target If QQQ trades at or below $414 by the expiration date, this trade could yield a return of 466% on the amount risked. With 50 contracts, this equates to risking $750 to potentially gain $4250. QQQ 6M mountain QQQ, 6 months Since this trade is taken as a hedge, the expectation should be that if the markets don’t tank after tech earnings, I will lose my initial investment. -Nishant Pant Founder: https://tradingextremes.com Author: Mean Reversion Trading Youtube, Twitter: @TheMeanTrader DISCLOSURES: (None) THE ABOVE CONTENT IS SUBJECT TO OUR TERMS AND CONDITIONS AND PRIVACY POLICY . THIS CONTENT IS PROVIDED FOR INFORMATIONAL PURPOSES ONLY AND DOES NOT CONSITUTE FINANCIAL, INVESTMENT, TAX OR LEGAL ADVICE OR A RECOMMENDATION TO BUY ANY SECURITY OR OTHER FINANCIAL ASSET. THE CONTENT IS GENERAL IN NATURE AND DOES NOT REFLECT ANY INDIVIDUAL’S UNIQUE PERSONAL CIRCUMSTANCES. THE ABOVE CONTENT MIGHT NOT BE SUITABLE FOR YOUR PARTICULAR CIRCUMSTANCES. BEFORE MAKING ANY FINANCIAL DECISIONS, YOU SHOULD STRONGLY CONSIDER SEEKING ADVICE FROM YOUR OWN FINANCIAL OR INVESTMENT ADVISOR. Click here for the full disclaimer.
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