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The madness in markets sent traders rushing to protect against more damage in tech stocks — here’s how their caution may have saved the day

Stocks got crushed over a six-day period, and no area was hit harder than the tech companies so responsible for pushing the market higher. Traders were paying a heavy premium to hedge against further losses in tech. The cost ...

fiery bull scared

  • Stocks got crushed over a six-day period, and no area was hit harder than the tech companies so responsible for pushing the market higher.
  • Traders were paying a heavy premium to hedge against further losses in tech. The cost had rarely been higher over the past decade.
  • This behavior seems to have been at least partially responsible for stemming losses in tech stocks and, by extension, the market at large.

The stock market has been in meltdown mode all week, which means traders have been watching their backs.

Amid the carnage that befell stocks through Thursday, they loaded up on hedges to protect against further wreckage. And their urgency to do so pushed costs to exorbitant heights.

This was especially true for the formerly red-hot tech sector, which until recently was the unstoppable engine driving the market to new highs. The cost to hedge against further losses in tech skyrocketed to levels seen on just a few occasions in the past several years.

And can you blame investors? The tech-heavy Nasdaq 100 index dropped 8.8% over a six-day period, outpacing losses in the benchmark S&P 500 by more than two percentage points.

A measure called skew, or the premium options traders are paying to protect against a 10% loss in the PowerShares QQQ Trust ETF over the next three months, relative to wagers on a similar increase, spiked to a level seen only five times in the past nine years.

In other words, investors had rarely been more defensively positioned for a tech meltdown.

QQQ hedging

This nervousness may actually turn out to be a saving grace for the market, since the surge in hedging costs shows investors are braced for the worst.

After all, skew was never this elevated — even at the height of the tech bubble, when downside protection was needed most. Theoretically, this type of preemptive behavior helped stem the sell-off.

Further, traders have made a habit out of buying the dip on weakness. It's a routine that has help extend the 9-1/2-year bull market to an unprecedented length.

Based on the market's sharp recovery on Friday, they seemed to have stepped up. Their hedges held them over, and now they're piling back in — at least for now.

SEE ALSO: Howard Marks made billions piling into the market at the depths of the financial crisis — here's why he's continuing to buy now, and what it would take for him to stop

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