(Note: The author of this fundamental analysis is a financial writer and portfolio manager. He and his clients own shares of GOOGL and NFLX)
The technology sector has come under considerable pressure since the afternoon of July 27, with the NASDAQ Composite falling by nearly 2 percent from the peak and the Technology Select Sector SPDR ETF (XLK ) down a similar amount. But the losses have been worse in some of the big FANG names like Amazon.com, Inc. (AMZN), Netflix, Inc. (NFLX) and Alphabet, Inc. (GOOGL ). It appears as though the recent weakness could be attributed to some of these stocks moving too far too fast, with investors looking to lighten their holdings before the end of the month.
Since the middle of May, we have seen three sharp sell-offs in the Technology ETF: on May 17, June 9, and July 17. These were fast and sharp movements which saw large intraday moves from high to lows.
In the chart below, we see the three occasions from a different point of view, and the cause of these sell-offs becomes quite clear. The green line identifies an uptrend in the Technology ETF since the February 2016 market lows, while identifying a resistance trend starting September of 2016, creating a channel. On three occasions the sharp sell-off in the the sector occurred when the ETF rose above the top side of the channel. The market has identified this as a signal to sell tech stocks, and each time has brought the ETF back within the range. A decline of the ETF to the bottom the channel, at approximately $56, would be a negative sign.
The options market tells its own story and looks overly bearish at first blush on the Tech ETF. That’s because options traders are trying to protect themselves from further downside movements in the group.
Over the next six months, September has the largest level of open interest, as you can see by the above graph.
One bearish indictor is that are roughly 86,000 puts open at the $50 strike price, and almost 67,000 contracts open at the $45 strike. The call activity, usually a bullish sign, is almost nonexistent in comparison with the largest open interest coming at the $56 strike price with approximately 9,700 contracts open.
But the put options with the $50 strike price trade at roughly 11 cents a contract, making the notional value of the open interest only $935,000. That indicates that investors are looking for inexpensive protection against a downdraft. Also, on the call side, the $56 options trade at a price of $2.00 a contract, giving them a notional value of $1.938 million, which suggests that the bullish sentiment is stronger.
So, to this point, the recent sell-off in tech seems like nothing more than some profit taking when the sector had gotten a bit too hot. As long, as the sector continues to remain in the channel, it is likely to continue trading higher, with the lack of sizeable downside bets in the options market confirming.
Michael Kramer is the Founder of Mott Capital Management LLC, a registered investment adviser, and the manager of the company’s actively managed, long-only Thematic Growth Portfolio. Kramer typically buys and holds stocks for a duration of three to five years. Click here for Kramer’s bio and his portfolio’s holdings. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein. Upon request, the advisor will provide a list of all recommendations made during the past twelve months. Past performance is not indicative of future performance.
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