Using Market-Maker Intelligence In Your Investments

Dec.23.13 | About: ProShares UltraPro (TQQQ)

Our recent SA article illustrated how market-makers [MMs] show more precise focus in their outlooks for the S&P500 index (SPX) than they do when hedging firm capital risks necessary to be taken in the SPDR S&P500 ETF (NYSEARCA:SPY).

The same condition exists in some other index vs. ETF outlooks. This article suggests one way to capitalize on the pros' skills and information resources in another specific case, involving the NASDAQ-100 index (NDX) and an ETF (3x) leveraged-long parallel, the ProShares Ultra Pro QQQ ETF (NASDAQ:TQQQ).

Here is what the past 6 months of market-maker forecasts for the NDX have looked like:

Click to enlarge

(used with permission)

Please do not confuse this picture with typical high-low-close "charts" of past price ranges. This is a history of real-time forecasts made live, daily over the past 6 months. The forecasts are inferred from the hedging actions of MMs, using options on the NDX index. While the options are available to the individual investor, the index is not directly investible, so most individuals use ETF alternatives. The ETFs track the index closely and reliably.

Here is what the MM forecasts for TQQQ have looked like in the same period:

Click to enlarge

Now here are measures of the prior price-change experiences of both, following earlier instances like their current balances of upside-to-downside expectations. First the index, then the ETF:

Click to enlarge

Click to enlarge

The ultimate price change outcome here is bound to be near-identical, save for any current tracking error by the ETF of the index. Note the differences in Range Index. The NDX, at an RI of 16 has 1/6th of its forecast range below its current price of $3531. The ETF has twice as much of its forecast range below the present $118 price.

We shouldn't be concerned about the absolute size of prices here; what is important is the percentage changes likely. Both securities are being appraised by the MMs as having an upside of +12.4%. Their downside appraisal is not shown, because the limited space available is regarded as being better spent on showing what the worst-case actual price drawdown experience average has been, rather than on today's conjecture of tomorrows.

That past drawdown experience for TQQQ at an RI of 34 is worthy of an examination by the investor of his personal fortitude when looking at an investment that might be nearly -10% under-water at cost. But there is useful reassurance that the TQQQ investment might not need to be closed out at such a loss.

Let's check out the confidence being carried by the MMs of their forecast of the NDX's near future. When the index had been seen previously at an RI of 16 (some 75 times in the past 5 years of 1261 market days) it has always (100% of 75 times) either reached its sell target, or been closed out at the end of the ensuing 3 months after each forecast, at a profit. The average simple % gain of all those instances has been +9.6%.

This is very reassuring experience. But it's no guarantee. Records are made to be broken. Past experience is no know the rest. But it may be a lot better than the taxi-driver or hotel barber saying "trust me, I know this one." You gotta make the decision; it's your capital at risk.

The point is that if the NDX gets there, somewhere on the upside, and TQQQ tracks it 3x worth, you should make out pretty well. TQQQ's past record has a very hefty annual rate of return; for many investors well worth the small chance of disappointment indicated among over 100 similar ventures, some of which probably have not had as strong a support as the current MM outlook on the index.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.