How To Use ETFs like TQQQ, SQQQ, QLD and QYLD during Volatile Times for Tech (QQQ)

For those who are still wondering about the reason for the fall of the mighty Nasdaq Composite Index, the chart below says it all. It basically shows the shares of the Invesco QQQ ETF (NASDAQ:QQQ) which tracks the Nasdaq 100 Index going steeply down as from January 3 with the fall coinciding with the rise of the 10-year treasury interest rate, which climbed to the 1.69% mark, a level not reached till January 24, 2020, or nearly two years back.

Looking back in hindsight, the volatility was already evident from the second half of 2021, as a result of QQQ (in blue) being inversely correlated to the 10-year rates in Orange.

Source: Initial charts obtained from Ycharts.com

Now, tech did stage a rebound on Wednesday with QQQ up by nearly 2.75% during the day, but the gains fizzled out after the Federal Reserve said it is likely to hike interest rates in March and reaffirmed plans to end bond purchases. There is also an indication that inflation risks are still present, as the U.S. central bank chief also mentioned the battle to tame inflation will have to be a sustained one.

Making sense of this new market regime

Now, inflation, especially high-inflation with the U.S. CPI (Consumer price index) at record highs is an issue for the whole economy, but more for tech stocks which normally exhibit higher growth but carry higher valuations as well. Thus, they are expected to deliver faster profit growth in the future to justify their high price to earnings multiples. This is in contrast to more “value” stocks coming mainly from the consumer staples sector possessing more pricing power to better face periods of inflationary pressure.

Still, during periods of high volatility as on Wednesday, QQQ, with its tech-heavy names ended the day in the green, slightly up at 0.08% while the Dow Jones Industrial Average which includes the more traditional sectors of the economy like cyclical more likely to benefit from the economic recovery, lost 0.38%.

Now, while some analysts think that it is too early to buy the dip, others at Goldman Sachs (GS) say that some tech sectors like semiconductors have been unduly punished while some defensive sectors have been rerated too much. Exploring further, results from a survey by Bank of America’s (BofA) Global Fund Manager reveals a bullish stance on stocks and expect inflation to fall in 2022.

Therefore with Wall Street analysts not aligned, this new market regime is likely to continue playing the yo-yo. On some occasions, you start by seeing the NASDAQ up by 1%-2%, but then, it finishes the day with only slim gains. At other times, the NASDAQ starts the day by being down by over 1%-2% and then finishes the day by reversing the losses.

These volatile market conditions constitute fertile grounds for traders.

Tools for trading

One solution, in case you have a trader profile, is to use highly leveraged ETFs like the ProShares UltraPro QQQ ETF (TQQQ) or the ProShares UltraPro Short QQQ ETF (SQQQ). First, TQQQ’s objective is simply to deliver triple the daily returns of Nasdaq-100. On the other hand, SQQQ also tracks the Nasdaq 100, but inversely at 3 times. This means that theoretically, if the QQQ jumps by 2%, TQQQ would deliver 6% of gains, and conversely, if QQQ falls by 2%, SQQQ would deliver 6% of upside. These are whopping gains considering that they can be obtained within a day or over a slightly longer period, but traders will obtain less than 6% in practice due to the compounding effect which is inherent in leveraged ETFs.

Consequently, due to compounding effects, do not expect TQQQ to deliver exactly three times the gains on the NASDAQ. The same is applies to SQQQ when tech names fall. Furthermore, far from forming part of a buy-and-hold investment strategy, these two leveraged ETFs are instruments best used over intraday time frames, and those betting on them should monitor news and economic indicators likely to sway the market. They should also be prepared to exit with a loss or, be “risk-tolerant”.

The two charts below show the 3%-4% gains made possible by these two leveraged tools, but here as seen by the rapidity with which the ups and downs occurs, timing is key in order to make a gain.

Source: Prepared by author using data from finance.yahoo.com

I now introduce two other ETFs for investors who are less risk-tolerant.

QLD and QYLD

My purpose for introducing the ProShares Ultra QQQ ETF (QLD) and the Global X Nasdaq 100 Covered Call ETF (QYLD) together is that they both have delivered exactly the same one-day performance on Wednesday, at 0.2%, outperforming QQQ by 0.12%.

Source: Ycharts.com

First, QLD offers 2x daily long leverage to the Nasdaq-100 Index, which is less than TQQQ’s 3x. This ETF becomes interesting in current market conditions where QQQ’s daily price actions suggest that in addition to being highly volatile over a daily period, it is not producing much uptrend on a longer-term basis. In this case QLD, by providing two times QQQ’s gains over the same period of time can more rapidly “aggregate” these small daily gains, making QLD a powerful tool for investors with a bullish outlook. However, as a leveraged fund, QLD is also impacted by compounding and is better traded on a short-term (one-month maximum) with constant monitoring of daily performance.

Exploring further, there is the QYLD, which follows a “covered call” or “buy-write” strategy, in which the fund managers buys the stocks in the Nasdaq 100 Index and “writes” or “sells” corresponding call options on the same index. For this purpose, it tracks Cboe Nasdaq-100 BuyWrite V2 Index. This is more of a long term buy-and-hold investment vehicle as it is designed to provide protection in periods when the NASDAQ falls. Thus, while QQQ fell by 13.4% since the start of this year, QYLD’s downside has been more moderated, at 8.7%. In addition, it pays regular monthly income with dividend yields of above 14%, which is really enticing.

Conclusion

Finally, these four ETFs could form part of an equity portfolio strategy where the aim is to provide some hedging (protection) while investors continue to be invested in tech or already own shares of QQQ. In this respect, one strategy which worked well in the last twenty months consisting of dip-buying is no longer working in this new market regime. Thus, instead of buying the dip in the hope of an elusive upside, it would be better to seek alternative strategies in view of the 10-year yields not having gone down yet and QQQ having dipped below its 200-day moving average last week.

Disclosure: This is an investment thesis and is intended for informational purposes. Investors are kindly requested to do additional research before investing.