The Odds for a NASDAQ 100 rebound

Posted by Derek Tomczyk on Apr 16, 2014 - 12:00am

I recently took a look at the Biotech ETF IBB and concluded that while the odds are the investment is ready to rebound they're not great in the very short term. In addition it appears that while the investment positive return odds are good on a 2 month time-frame they carry above average risk of a large draw down in case of negative outcomes. I will now compare this result with a similar analysis for the Powershares NASDAQ 100 ETF (QQQ)

The histograms below have the probabilities in percentage on the left y-axis and ranges of prices/returns on the bottom x-axis. The dark green indicates historical probabilities without consideration for the current point in time while light green probabilities are calculated based on periods with similar characteristics to today.

First probabilities for May 17th

In contrast to the May 17th probability histogram for IBB the QQQ histogram appears to show a slight tilt to positive outcomes especially ones larger than normal. Notice the light green bars are far higher than the dark green bars for QQQ returns between 7% and 13%. In addition this distribution appears to have less than normal probabilities of negative returns.

The stats confirm the favourable expectations with an expected return more than twice the norm for May 17th. The average rally is slightly higher than normal while the average drop is lower than normal and the probability of a positive return is 65% versus 60%. The 1st standard deviation of returns is where the majority of the improved odds are which means the bet would be one that is expected to pay off a large percentage of the time. This looks like a very good risk/reward opportunity for any position exposed to long QQQ, even holding the ETF outright.

Next probabilities for June 21st

The probability curve for June 21st is far more narrow then normal. This does not tell us so much about the direction but rather indicates an expectation of a more narrow range of outcomes. The curve is titled to the positive side a bit, but mostly due to a reduced probability of very negative outcomes rather than an expectation of very positive outcomes.

The stats also tell us a similar story with the expected ROR for the period being larger than normal but not quite as extreme as for May 17th. The probability of a positive investment return is above normal, but less so, and the average rally is less than normal but so is the average drop.

This is a situation where an outright position in the ETF or a deep in the money option are better choices than out of the money option bets. The probability of a large loss on QQQ by June 21st, in direct contrast to IBB, is far below normal so exposing yourself to the risk is a better choice than paying a premium for protection. There is a also a larger than normal probability of a return up to 9% so a leveraged position may a good choice at this time. Therefore much better opportunities for call option positions out of the money lie in the May 17th option chain.

Click here to search for QQQ options that will generate a profit by May 17th given an average rally

While I try to stick to the facts throughout the rest of the web site the blog is the "unplugged" piece and is entirely my personal opinion which is very likely wrong and should definitely not be used for making investment decisions.