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The action of the PowerShares QQQ Trust, Series 1 (ETF) (NASDAQ:QQQ - 65.35) will be worth watching when trading resumes tomorrow. QQQ has performed well so far in 2012, and is up 17% year-to-date. However, shares have been slipping lately and are now 7.4% below the 52-week highs set in mid-September. Volatility has been picking up and, looking at the term structure of implied volatility in QQQ options, some players in the options market seem to expect the trend to continue heading into 2013.

Sizing Up the QQQ

QQQ is one of the more actively traded funds with among the most popular options contracts today. Sometimes called "the Qs," shares represent ownership in the same stocks of the NASDAQ-100 Index (NDX). The index, in turn, includes the top 100 non-financial names that trade on the Nasdaq, and therefore large technology names like Apple Inc. (NASDAQ:AAPL), Intel Corporation (NASDAQ:INTC), and Microsoft Corporation (NASDAQ:MSFT) dominate both the Qs and NDX. Each QQQ share is designed to equal roughly 1/40th of the NDX. So with NDX trading at 2,665, one share of the Qs can be purchased for about $65.50.

QQQ has been drifting lower since its mid-September highs and, as we can see from the chart below, is testing a key support level around its 200-day moving average. That level also corresponds with trendline support after last year’s August and October lows. It will be interesting to see if those levels hold when trading resumes later in the week and into the final two months of 2012.

Daily Chart of QQQ since September 2011
Chart courtesy of

Ticking Higher

While the Qs have been drifting lower over the past six weeks, implied volatility in the options on the ETF have been moving higher. One can easily get a real-time reading on implied volatility in QQQ options with the QQQ Volatility Index. Listed under the ticker QQV (or sometimes $QQV), the index is similar to the widely watched CBOE Volatility Index (VIX). But, while VIX tracks the expected or implied volatility priced into S&P 500 Index (SPX) options, QQV is based on a similar methodology and applied to options on the Qs.

In mid-September, when QQQ was moving north of $70 per share and to its highest levels in over a decade, QQV fell to a near-record low of 12.09. The decline in the index suggested that implied volatility in QQQ options had fallen to very low levels and the options had become "cheap." Since then, QQV has rebounded to 18, but remains relatively low compared to past levels. For example, at this time last year, QQV was moving above 30.

Daily Chart of QQV since September 2011
Chart courtesy of

An Important Term to Consider

Looking at the QQV alone doesn’t tell the entire story about QQQ implied volatility, however. The index considers only an average of at-the-money one-month options. It doesn’t factor in the implied volatility of longer-dated QQQ options. In today’s market, implied volatility in many of the index and ETF products is typically greater in the more distant expirations compared to the short-term options.

The figure below shows the term structure of QQQ options. While the near-term options have implied volatility of less than 20%, the longer-term contracts that expire in January 2014 and December 2014 have much higher levels, where implied volatility is 22% and 24%, respectively. The steepness in the term structure of implied volatility reflects the fact that market participants seem to believe there is a greater chance of higher volatility over the next two years rather than the next few months.

Term Structure of QQQ Options
Chart courtesy of Trade-Alert

Wait Until Next Year!

As options traders, we spend a lot of time studying volatility. It matters, not only for finding the best strategies, but also determining whether options are relatively cheap or expensive. A variety of indexes, like VIX and QQV, have been created over the years and are helpful in seeing changes in implied volatility in real-time, but also over periods of months and years.

In the current market, the indexes don’t really tell the entire story. The term structure of implied volatility is very steep, suggesting the longer-dated options typically trade at higher vols relative to short-term. In short, market participants are perhaps "pricing in" the possibility of higher levels of market volatility in 2013 than what we’ve seen throughout most of 2012. The action of the Qs in the short term (whether or not support holds) and during the final two months of 2012 might offer early clues whether or not those concerns are justified.

As senior analyst for, Fred provides regular notes and daily updates on interesting trading activity and advanced option topics.

Disclaimer: The views represented on this blog are those of the individual authors only, and do not necessarily represent the views of Schaeffer's Investment Research.

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