The Nasdaq 100 index continues to set new historical highs. Calculated based on total return (including price increases and dividends), the index has risen by more than 24% so far this year; since the end of 2022, with reinvestment of dividends, the cumulative increase is nearly threefold, reaching 193.37%. If you feel both fear of having missed out and a bit dizzy due to this surge, read on.

A notable feature of this round of gains is its "relatively limited breadth." The majority of the overall index increase was still driven by the same group of super-large market capitalization tech giants. The top 10 companies with the largest market capitalization in the NDX index account for half of the index's total market capitalization weight.

This narrow leading rally pattern means that the market heavily relies on a small group of not-so-diversified companies. For investors who wish to continue participating in the upward trend while reducing the risk of a sudden reversal by these companies, the options market may provide a solution: to go long on tech stocks in a way that strictly defines the risks.

The key to achieving this is a bit of a mouthful to pronounce, and it’s called “implied correlation.” But please listen patiently; it’s well worth it. Implied correlation is a supplementary concept to implied volatility, which is the way options traders measure option prices. When the implied correlation of a certain index is low, the price of index options will also be lower relative to the prices of individual stock options. Think about what this means: a few stocks are driving the index’s returns, but the pricing of index options suggests as if the index is highly diversified, as if there’s no concern that a similarly narrow upward path might suddenly reverse.

Currently, the one-month forward correlation for NDX is only 0.177. When viewed over a longer period, this level is approximately at the 25th percentile, close to the three-year low of 0.128 rather than the three-year high of 0.567. At the same time, the one-month rolling correlation is currently at 0.158. There is another factor to consider: among the upcoming near-term catalysts, such as financial reports, wars, and mid-term elections, how many will be more specific to individual stocks rather than being macro-related?

Basically, the NDX or QQQ options have now obtained a rather favorable “fair price”, making them suitable for going long on the premium. You haven’t paid an excessively high price for the index volatility. With the mid-term elections in November approaching, there may be a new round of headline risks and sector rotation injected into the market. Considering the elections, the upcoming earnings reports from major tech stocks, and the changing macro data, the market environment is likely to see greater index volatility.

Therefore, rather than directly buying QQQ and exposing the portfolio to significant downside risks, it is a smarter and more cost-effective way to go long by purchasing call options at the current option price.

Trading suggestion: Buy QQQ November 760 call option

• Bought QQQ November 760 call options for approximately $22.70. The cost of these at-the-money options is only equivalent to 3% of the current price of the underlying ETF.
• Return:There is no upper limit to the upside. If the mid-term elections eliminate uncertainty and tech stocks lead the gains, continuing to push the index to new highs, these bullish options will provide leveraged opportunities for participation in the upward movement.
• Risks:The risk is strictly limited to the paid premium, which is $2,270 per contract. If this narrow-market situation eventually wears out and prices fall back, the capital risk you face is mathematically capped at 3%.

Disclosure:Tidal holds all the securities mentioned in the text.

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