Tim Bovee, Private Trader: QQQ: Swift-footed Achilles

Update 10/2/2014: QQQ closed below the 20-day price channel and I've removed it from the Roll Shelf.

The stock lost 0.1% during the 37 days I held my position, or -0.9% annualized. The options spread produced a 1.7% loss on risk, or -17.1% annualized.

Update 9/26/2014: I've exited my bull position in QQQ and placed the symbol on the Roll Shelf. QQQ closed below its stop/loss level on Sept. 25 and confirmed the exit signal the next day. The confirmation day close was above the 20-day price channel's lower boundary, so QQQ goes on the Roll Shelf for re-entry if it breaks above the 20-day channel. I'll defer calculating profit and loss until no further rolls are possible in the series.

On the chart, the Elliott wave framing places the Sept. 19 high as the end of wave 3 {-2} and the beginning of a 4th wave correction to the downside. I've counted the movement from the date as the five-wave internal count within wave A {-3}, although the correction could well take a somewhat different form.

Under Elliott doctrine, the end of wave 4 {-2} will be followed by a rise above the Sept. 19 high of $100.47.

Click on chart to enlarge.

QQQ 10 days 10-minute bars

Update 8/20/2014: I've opened a bull position in QQQ, structuring it as a bull call vertical spread, long the $98 calls and short the $99 calls, bought with a debit and expiring Dec. 19.

The spread has 9:1 leverage.

The Qs -- QQQ, an exchange-traded fund tracking the Nasdaq 100 -- is along with SPY part of the Big Guns of market analysis. SPY, tracking the S&P 500, covers the blue chips, the story goes, and the Qs track the techs.

That's the conventional wisdom, and as always, it simplifies. True, the Nasdaq does cover a lot of tech stocks. It is routinely referred to in market reporting by the epithet, the "tech-heavy Nasdaq", much as Homer in the Iliad refers repeated to "swift-footed Achilles".

But SPY also has techs, and QQQ has non-techs. Reality is rarely neat and clean.

Even so, in the markets today, Achilles -- I mean, the Qs -- remains swift-footed, sprinting through the final leg of a rise that began in November 2012.

The Chart

Elliott wave framing places QQQ in a series of 3rd waves of expanding degree, rising from November 2012, and in from November 2011, August 2011 and November 2008.

That count gives the Qs much upside potential, but that labeling at the smaller degree as a 5th wave suggests that the next major move will be a downward correction that will take back a portion of the rise from $61.31.

Afterward, QQQ will resume its uptrend, moving above $98.82, perhaps significantly above that level.

Click on chart to enlarge.

QQQ 15 years 5 months monthly bars (left), 4 years 4 months 2-day bars (center), 90 days 4-hour bars (right)

The heart of the matter is the question of how far that 5th wave, wave 5 {-1} in my count, has advanced.

I see the wave as being in its middle leg, wave 3 {-2}, which in turn in in its final leg, wave 5 {-3}, beginning Aug. 7.

There's no way to set targets on this rise. This much is known. Given the framing I've laid out, the end of wave 5 {-3} will begin a correction taking back a portion of the rise from $93.89. Afterward, QQQ will go on to new highs, above $98.82 in order to complete wave 3 {-2} to the upside.

The end of wave 3 {-2} will take back a portion of the rise from $83.28, and then push up to new highs again.

There's no way how long it might takes wave 3 {-2} to do its work. It has already lasted 11 months. The 1st wave in the series lasted 40 months. If the 3rd wave is of comparable duration, then it would carry into August 2015.

The leading Elliottician of our time, Robert Prechter, has a count that is significantly more bearish than mine. And he may well be right. Prechter has done an amazing job of pushing broad-market counts back into history, using a variety of sources. I'm limited to the 20-year span allowed by most brokerage charting systems.

Within the universe of information available to me, I believe my count is valid. But if I've learned anything in my years of working with Elliott wave analysis, it has been that is has a protean nature.

Elliott is a framing device, not vox dei.

Odds and Yields

QQQ has produced 10 bull signals since wave 3 began in November 2012, half successful and half not. The successful trades on average yielded 2.9% over 35 days, and the unsuccessful signals lost 1.3% over 22 days. The resulting 1.6% win/lose yield spread, while positive, is unimpressive.

One of the signal occurred in wave 3 {-2}, which began last April. It yielded an impressive 7.3% over 57 days.

The Fund

The PowerShares QQQ Trust Series 1, to give QQQ its formal name, tracks the Nasdaq 100. The fund is managed by Invesco Power Shares Capital Management LLC of Wheaton, Illinois.

The expense ratio is low, at 0.2%. It's top holdings are a litany of tech icons: Apple Inc., Microsofot Corp. Google Inc., Intel, Facebook Inc., Amazon.com Inc. and so forth.

The fund goes ex-dividend in September for a quarterly payout of 25 cents per shares, for an annualized yield of 0.98% at today's prices. The yield on 10-year U.S. Treasury notes, by comparison, is 2.42%.

Liquidity and Volatility

QQQ on average trades 33.2 million shares per day, placing it within the top 10 exchange-traded funds.

It supports an extremely wide selection of option strike prices spaced less than 50 cents apart at the money with open interest running as high as five figures on some strikes. In addition to the usual monthly options, it also has weeklies and quarterlys. The underlying Nasdaq 100 also trades as futures and as options on the futures under the symbol NDX.

The front-month at-the-money bid/ask spread on calls is 0.8%, compared to 0.5% spread on SPY, the most-traded symbol on the U.S. exchanges.

Implied volatility stands at 13%, compared to 12% for the S&P 500, and has fallen from 18% since Aug. 1.

QQQ's volatility is in the 12th percentile of its one-year range, suggesting that long vertical spreads bought with a debit have the best chance of success.

Options are pricing in confidence that 68.2% of trades will fall between $95.12 and $102.46 over the next month, for a potential gain or loss of 3.7%, and between $97.03 and $100.55 over the next week. I've marked the monthly range on the chart in blue.

Contracts today are trading slowly, with calls running at about 40% below their five-day average volume and puts at half their average.

Decision for My Account

I intend to open bull position in QQQ under my short-term rules. It is a very liquid symbol and my chart analysis suggests much room to the upside. I intend to structure the position is a bull call spread expiring in December.

-- Tim Bovee, Portland, Oregon, Aug. 20, 2014

References

My shorter-term trading rules can be read here. My longer-term trading rules can be read here. And the classic Turtle Trading rules on which my rules are based can be read here.

From time to time I use the number 68.2% in using applied volatility to calculate the expected trading range. This comes from statistics and refers to the one standard deviation boundaries, which are expected to contain 68.2% of whatever is being studied. Putting it another way, given an item (a trade or whatever), there is a 68.2% chance that it will appear within those boundaries.

Elliott wave analysis tracks patterns in price movements. The principal practitioner of Elliott wave analysis is Robert Prechter at Elliott Wave International. His book, Elliott Wave Principle, is a must-read for people interested in this form of analysis, as is his most recent publication, Visual Guide to Elliott Wave Trading.

Several web sites summarize Elliott wave theory, among them, Investopedia, StockCharts and Wikipedia.

See my post "Chart Analysis: Nomenclature" for an explanation of my method for labeling waves on the chart.

By preference I place my shorter-term trades in the last half hour before the closing bell in New York. See my essay "When is the best time to trade" for a discussion of the practice.

Disclaimer

Tim Bovee, Private Trader tracks the analysis and trades of a private trader for his own accounts. Nothing in this blog constitutes a recommendation to buy or sell stocks, options or any other financial instrument. The only purpose of this blog is to provide education and entertainment.

No trader is ever 100 percent successful in his or her trades. Trading in the stock and option markets is risky and uncertain. Each trader must make trading decisions for his or her own account, and take responsibility for the consequences.