Betting On A Nasdaq Bottom With TQQQ Puts With Potential 18.6% Yield

Author’s note: A modified version of this article was shared with Cash Builder Opportunities members on January 6, 2023.

To say that the timing of my previous put idea shared on ProShares UltraPro QQQ (NASDAQ:TQQQ) was unlucky, would be an understatement. Not a mere two weeks after I sold the put, Russia invaded Ukraine, which was arguably one of the main triggers for setting into motion the inflation that would rage around the world in 2022. Growth stocks, such as those contained in the NASDAQ, were hit hard, and TQQQ being the 3x leveraged version of the Invesco QQQ Trust (QQQ), felt triple the pain.

When we sold the TQQQ put on February 10, 2022, our logic was presented thus:

Let’s circle back to the current trade idea, where I’m showcasing the $20 put for TQQQ expiring on January 20th, 2023, which is around 1 year from now. TQQQ currently trades at $59.18, so the put has -66% nominal downside protection, but that’s really only around -22% on the NASDAQ due to TQQQ’s 3x leverage. I still view this as a pretty good buffer, since a $20 strike price would bring us back to prices not seen since May 2020, but remember that in investing anything can happen. This put has a delta of 0.052 currently, suggesting that the market is pricing in about a 5% chance of the put being in the money at expiration.

Turns out that -22% margin of safety on the NASDAQ was not enough, and the improbable became reality.

TQQQ currently sits at $17.69, so the $20 puts are in the money. We sold those puts for $1.90, so we could close this trade now at a modest loss of 68 cents by rebuying the option at $2.58. Alternatively, one could take assignment of TQQQ shares if they wished to, assuming that TQQQ still trades below the strike price of $20 by the expiry date of January 20th, 2023.

For our conservative investors who followed this trade, it may just be the most prudent to take the small loss now. This result illustrates one of the main advantages of option writing. Even though TQQQ fell by -69.77% over this time frame, our put option trade is only down -3.40% (a 68 cent loss divided by the initial capital outlay of $20). This is because we executed the original trade with a large margin of safety, and it only took a war in Europe and the fastest pace of rate hikes in history to sabotage this trade. This ide would have generated up to +10.1% in annualized option premium yield, had it been successful.

As I have a greater risk tolerance, I decided to roll this option again another year out to the January 19th, 2024 expiration. I’m giving the NASDAQ one more year to recover, while at the same time increasing my margin of safety of the put by rolling from the $20 put to the $12 put. This once again returns the option into “out of the money” territory, with a -32.2% margin of safety (approx. -10.7% on the NASDAQ). The put can be sold for around $2.30, so the cost of rolling the option is 28 cents. The annualized yield on this option is 18.56%.

The trade

The Trade: Sell to Open ProShares UltraPro QQQ (TQQQ) January 19th, 2024 $12 Puts – collected $2.30, stock price at $17.69.

Ticker: TQQQ

Expiration: January 19th, 2024

Type: Sold Puts

Strike Price: $12

Price Move Until Strike: -32.2% decline (approx. -10.7% on the NASDAQ)

Premium Collected: $2.30 or $2.30 per contract

Days To Expiration: 377 days

Annualized Return: 18.56%

Breakeven: $9.70 (Max loss $970 per contract achieved if the stock goes to $0)

Option Volume: Moderate, with a $2.22/$2.35 bid-ask spread at the time of writing. Use limit orders or accept a less favorable fill.

Dividend Equivalent: not applicable

In essence, we’re banking on a bottom on the NASDAQ being not far from here for this put option trade to be successful and generate 18.56% in premium yield. At a strike price of $12, TQQQ can fall up to -32.2% from current prices (approx. -10.7% on the NASDAQ) before returns start to get diminished. The trade will start to see losses if TQQQ drops below $9.70, which is -45.2% from current prices (approx. -15.1% on the NASDAQ). Can tech stocks fall another -15% from here? Absolutely, although from a valuation perspective, we’re back into neutral territory by most measures on the S&P 500, after the frothy heights reached in late 2020-early 2021 (see this chart from JPMorgan’s Guide to the Markets, data December 31, 2022).

Note that one drawback with selling puts on TQQQ is that leverage decay is not on your side. Leverage decay (or beta slippage) refers to the idea that a leveraged fund may decline slightly during volatile periods even when the underlying index ends up flat.