- Rising bond yields and looming interest rate increases have clobbered tech stocks and crypto.
- Don Kaufman breaks down an options trade to sustain risks as volatility is expected to pick up.
- He also explains what’s behind bitcoin’s growing correlation with high-growth tech stocks.
All of a sudden, the prospect of as many as four Fed rate hikes in 2022 has become the consensus on Wall Street.
The dramatic repricing pushed yields on the 10-year US Treasury note to a two-year high of 1.85% on Tuesday, while the S&P 500 and Nasdaq ended the day shedding 1.8% and 2.6%, respectively. The crypto market was also off to a rocky start as its total market capitalization declined 1.17% over the last day to $1.98 trillion, according to CoinMarketCap.
To veteran traders and investors, the outlook is clear: the era of ultra-low interest rates, which fueled the extraordinary boom in high-growth and oftentimes speculative investments, is over. This is further evidenced by investors’ swift rotation out of expensive tech stocks and into cyclical value stocks, which have been out of favor for over a decade.
Don Kaufman, a 21-year veteran trader who had spent over 15 years with TD Ameritrade’s thinkorswim trading platform, is seeing “a definitive change in the tone and feel of the market,” with all signs pointing to higher
“It’s been years since I’ve woken up in the middle of the night and looked at futures three or four times, but we are coming back to that,” Kaufman, the co-founder of trading educational platform TheoTrade, said in an interview.
An options trade to minimize risk amid volatility spikes
Despite the macro fears that have infected global financial markets, investors do not necessarily need to exit the market or go to cash. They do, however, need to evolve with the changing tides, according to Kaufman.
For those engaged in options trading, which has exploded in popularity over the past two years, that means learning how to mitigate risk through the use of spreads instead of simply buying call or put options, he explained.
The options spread strategy is executed when a trader simultaneously buys one option and sells another option at a higher or lower strike price using either calls or puts.
The trade can be expressed in four ways. A bull call spread involves buying a call option and selling another call option at a higher strike price. A bear call spread means selling a call option while buying another call option at a higher strike price. A bull put spread means selling a put option and then buying a put option at a lower strike price. A bear put spread calls for buying a put option and selling another put option at a lower strike price.
Kaufman explains that by using spreads, traders can “sustain the risks long enough to see the light of profitability,” meaning that they are less likely to be knocked out of a hyper-volatile market with a two-sided trade.
“There’s too much volatility to survive buying a call or a put because the price action is just too much,” he said. “When the volatility drives the price up, they buy a call. When the volatility contracts, they are just getting crushed and ripped apart. We’re seeing it every single day right now.”
Bitcoin trading in tandem with tech stocks
In Kaufman’s view, volatility will also seep into the crypto market in greater magnitude.
According to a Monday Glassnode research note, bitcoin’s perpetual futures open interest on all exchanges has surged to a historically elevated level of around 250,000 BTC, which has led to “large pivots in price action” since April 2021.
The volatility spike in crypto is likely to track that of high-growth tech stocks. As of January 14, the 100-day correlation coefficient of bitcoin and the Nasdaq was 0.40, according to Bloomberg.
This could be the result of persistent retail dip-buying activities over the past two years, according to Kaufman.
He observed that a large group of retail traders has been using leverage to buy the dip in tech stocks such as Tesla and Nvidia every time the market experiences a sell-off. Because pattern day traders must maintain minimum equity of $25,000 in their margin accounts in order to make any trades, many of these traders, who had less than $25,000 or saw their accounts fall below $25,000, would turn to crypto after they are cut off, he noted.
“Since the onset of Covid, they are literally toggling right back and forth between the same five stocks and then going right back to bitcoin, ” Kaufman said. “As the volatility picked up, those traders are kind of disengaged and a little disillusioned.”
To get retail investors re-engaged with bitcoin, he thinks it would have to take a major breakdown that sees the token consolidate around $30,000.
“In my estimation, this marketplace in crypto has to get ugly,” he said. “It has to get so ugly that it starts to flush some of the weaker hands out of it and get to a level to where people actually want to get involved and engaged again.”