Options Corner: Why QQQ ETF's Death Cross Is Actually A Hidden Contrarian Signal

While the equities market — particularly the technology sector — has bounced strongly from this week's chaotic opening round, a cloud of pessimism still lingers. Over the last several days, the business media ecosystem has been abuzz about the flashing of the dreaded death cross, both in the S&P 500 and the Nasdaq-100. Nevertheless, for the tech-centric Invesco QQQ Trust QQQ, the signal could be a contrarian one.

At first glance, the death cross appears to be a credible warning. Technically speaking, it's an arithmetic exercise where a shorter-running trend line (typically the 50-day moving average) dips below a longer running one (i.e. 200 DMA). Further, consumer behavioral patterns have shifted, indicating greater sensitivity toward economic challenges. As such, investors may question the prudence of the QQQ exchange-traded fund.

Still, the facts point to a far different conclusion than the name of the dreaded indicator implies. Over the trailing decade, the death cross has only represented a harbinger of doom in 2022. Otherwise, the pessimistically titled intersection has been a consistently strong buying signal.

On Oct. 2, 2015, the death cross flashed, with the QQQ ETF at $96.64. One year later, the fund stood at $111.40.
On Feb. 8, 2016, the death cross flashed at $90.05, reaching $119.22 a year later.
On Dec. 4, 2018, the signal read $158.49, reaching $195.34 over the next 52 weeks.
On May 1, 2020, the pandemic dropped the QQQ to $206.17, eventually reaching $327.84.
On May 2, 2022, the tech fund slipped to $339.81, providing the sole outlier when it only managed to reach $289.46 a year later.

One reason why the death cross seems to offer an accurate contrarian signal — at least in modern times — is that it's a lagging indicator. Essentially, the bad news that created the signal has already worked itself into the price discovery mechanism. By the time the moving averages "catch up," the bears are exhausted and the bulls are in recovery mode.

Deciphering the Hidden Momentum Signal Behind the QQQ ETF

As headlines focus on the ominous overtone of the death cross label, investors will have noticed that the tech ecosystem — led by giants like Nvidia Corp NVDA, Apple Inc AAPL, Microsoft Corp MSFT and many others — has marched its way above Monday's rough opener. It raises natural questions about whether the move can be sustained.

Attempting to answer this inquiry requires, obviously, analysis. The problem with market analysis is that stock prices, representing an infinite continuum of possibilities, do not speak the same language. To address this dilemma, one can compress all the chaos of price discovery into defined, discrete events. Because discrete events have clear boundaries, the transition from one state of existence to another can be tabulated — and this tabulation can yield probabilities.

In other words, rather than comparing prices of the QQQ ETF which can vary wildly across regimes, one can compare patterns. For example, over the past 10 weeks, the tech fund is currently riding a "3-7" sequence: three up weeks interspersed with seven down weeks, with an overall negative trajectory from beginning to end. The significance of this sequence is that in the trailing decade, the 11th week generates long odds of 65.38%.

By the conclusion of this week, the QQQ ETF will likely print a 4-6 sequence, with a net negative tilt. This sequence also carries positive implications, with next-week long odds of 64.58%, combined with a median return of 1.95%.

To be clear, probabilities are just that — they're educated guesses, not guarantees. But based on the recurring patterns of QQQ ETF, the bulls likely have the wind at their back.

Taking a Swing at the Benchmark Tech Fund

Based on the aforementioned historical patterns, the QQQ ETF median upside return target by the end of next week is 1.95% up. With that in mind, speculators may consider the 470/472 bull call spread expiring May 2. This transaction involves buying the $470 call and simultaneously selling the $472 call, for a net debit paid of $102.

Should the QQQ ETF rise through the short strike price of $472 (about 1.5% away from the current market price), the maximum reward is $98, a payout of just over 96%.

For ultra-aggressive traders, the bulls may attempt to knock out the psychological price target of $500. To really go for it, extreme gamblers may consider the 496/500 bull call spread expiring May 30. This transaction requires a net debit of $106. However, if the QQQ rises through the short strike at expiration, the reward stands at $294, a massive payout of over 277%.

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