45% of Nasdaq Now Down 50% from Highs- Options Trade Examples

It was quite a week for the markets with the Nasdaq dropping 7.6%, the S&P 500 5.7%, and the Dow 4.6%.  The Nasdaq is now down 15.1% from its November high and is off 12% YTD.  Staggeringly, 45% of Nasdaq equities are off 50% from their highs.  There were not many places for solace as cryptocurrencies sold off as well.  Bitcoin is now down 45% from hits 2021 highs reached in November, while Ethereum is down 42%.

Most relevantly for us, the volatility index increased by over 50% for the week, which was the 17th biggest weekly rise since 1990.  This raises the price of options causing short-term mark to market losses that reverse upon expiration as time and volatility go to zero.  It also is a major benefit for us in that we are able to sell options for extremely attractive premiums.  I thought it would be helpful to show you a few ways in which we’ve been able to take advantage of volatility.  While of course, our focus is on the deep value side, these are some examples of when high growth stocks turn into deep value plays.

$PTON stock has a 52-week high of $166.57 and the stock now trades at $27.06.  This week, we were able to sell $10 puts expiring in 1 year, for $1.20.  $120/$880 (maximum risk)= Target profit of 13.6%.  The stock would have to drop by 67.5% at expiration for you to lose money.  There is a very real business there with recurring revenues and attractive product margins, but the stock was caught up in an epic bubble.  We would be happy to own the stock at those levels (breakeven price of $8.80 per share) if we were exercised.

$RBLX is well known to anyone that has young children or grandchildren active with computers.  The products is so user-friendly that kids can create their own games and “Meta-worlds.”  The 3D graphics are exceptional and Roblox can be accessed on a variety of different platforms such as Oculus Rift, Xbox, Android, and iOS.  The revenue generating opportunities are simply enormous.  I think the company has quite a few similarities with Facebook in the early days, in terms of its growth prospects.   The IPO in 2021 was one of the hottest of the year and the stock topped out at $141.60.  This week, we can sell puts at $40 for between $4.40-$4.70.  The stock trades around $68.93.  We are targeting 12.3% returns in one year.  The stock would have to drop by another 48% at expiration for us to lose and at that point, we would end up owning the stock that could double or triple within a few years.

This is not March of 2020.  The global economy is not locking down in response to a pandemic, which literally jeopardized just about every industry, except the few that benefited from people staying at home.  This is a nearly Everything Bubble being deflated and possibly popping.  It might get worse before it gets better, but it is impossible to know for sure, as sentiment can change on a dime.  There aren’t any credit issues emerging thus far, which is a major positive, but on the negative side, the Fed is a bit hamstrung as it must confront the inflation monster.  What I do know is that we don’t own the bubble stocks and asset classes.  The companies we own produce enormous cash flows, pay big dividends for the most part, and trade at cheap valuations.  They are financially strong companies that can take advantage of the dislocations with stock buybacks and strategic acquisitions.  I think you can see from our examples that we are being quite conservative, but are still finding attractive opportunities to target mid-teens returns.

Many people think that the stocks such as $MSFT and $AAPL are invulnerable.  They forget that $MSFT bottomed out in 2008 at a valuation of 2x Enterprise Value/Sales.  The stock did not trade over 3x until 2014.  It recently topped out at 12x and is now trading over 10x.  The company has done great, don’t get me wrong, and it will continue to do well.  However, stock prices can expand too far on the upside, and correct too far on the downside.  Our job is to take advantage of these ebbs and flows.  You can see that chart on Microsoft at the bottom of this email.  Because the Nasdaq now has such concentration with 40.753% of its weighting in just $AAPL, $MSFT, $GOOGL, $AMZN, and $FB, the indices are immensely susceptible to another lost decade like 2000-2010.  This is where options and security selection really become just essential tools and we are ready to roll.