Data Shows Why This Software ETF is Poised to Rally

At the beginning of June, I wrote about two sector exchange traded funds (ETFs) that had become significantly overextended. The VanEck Semiconductor ETF (SMH) was trading more than 50% above its 200-day moving average, while the iShares Software ETF (IGV) was over 25% above its 50-day moving average.

Historical data showed that after reaching these extreme levels, sector ETFs tended to experience a short-term pullback before resuming a longer-term uptrend. Specifically, it highlighted the following month's underperformance and outperformance. Since May, however, SMH has chopped around to a 5% gain. IGV has pulled back sharply potentially creating a buying opportunity if history is any indicator. 

Plus, with that historical trend in mind, IGV could outperform for the next several months. In this article, I’ll look at the stock holdings of the ETF and see if we can find some favorite individual plays based on the data.

IGV Holdings and Performance Data

The table below lists the top holdings of the IGV software ETF along with some stock performance data. I show month-to-date, year-to-date, and year-over-year returns. The last column in the table shows where the stock is relative to the last year of trading (0% means it’s at its low and 100% means it’s at its high).

I sorted the list by the stock’s performance since the end of May. For those looking for pullbacks, since that’s the pattern that has played out in the past, it’s the stocks at the top of the table that have pulled back the most recently. If you’re looking for a pullback but want to avoid a beaten down stock, AppLovin' (APP) has pulled back sharply, though its 52-week range shows 41%. Several stocks near the bottom of the table have been strong long-term and held up well over the past month when most of the sector had struggled.

The next table shows the same stocks as above—this time with analyst data, option buy-to-open (BTO) data, and our Schaeffer’s Volatility Scorecard (SVS). I will also mention why these could be relevant to picking equities and touch on some of the notable stocks.

The ‘Analyst Percent Buys’ column comes from Zacks showing the percentage of analysts rating the company a buy rather than a hold or sell. If investors have faith in the analysts, they might follow these recommendations, but we tend to use them as contrarian indicators. Specializing in option trading, we look for stocks with the potential to make a big move within a short to medium term.

Fortinet (FTNT) stands out. In the table above, we see FTNT is at a 52-week high (52-week range at 100%) and has been strong over each time frame. Despite this, only 21% of analysts recommend a buy for the stock. If the stock continues like this, those analysts will have no choice but to capitulate and set the scene for a wave of upgrades. In that scenario, the stock could propel higher.

We get options data from multiple exchanges separating out the volume by whether it was initiated by a buyer or seller of the option and whether it was opening or closing data. Focusing on bought-to-open (BTO) data, the option volume is more likely to be speculative buying, giving a clearer picture of sentiment. Again, FTNT looks like a good contrarian set up. It’s at an all-time high but put buying has been more popular than call buying as indicated by the call/put ratio of 0.41, meaning about 2.5 puts have been purchased for every call.

Over the past year, this level’s percent rank is 35%. Datadog (DDOG) also stands out in this respect. The BTO call/put ratio is below one, at 0.75 and it’s the lowest ratio in the last year (or the most puts bought to open relative to calls compared to anytime in the past year). DDOG is up 93% on the year.

The last column of the table shows the Volatility Scorecard of the stock. This is a value between 0 and 100 that ranks stocks by how profitable option premium buying has been over the past year. A high figure means that options have tended to be underpriced. A number of these stocks have very high scores. DDOG, which we just mentioned, is one of them. CrowdStrike (CRWD), Fair Isaac (FICO), Strategy (MSTR), Oracle (ORCL), and Synopsys (SNPS) all have scores in the 90s.

Someone with conviction on the timing and direction of these stocks might consider purchasing an option to gain some leverage. FTNT, which we mentioned above, has a relatively low score of 31. This means premium buying hasn’t been as profitable on this stock over the past year. An option buyer may need more conviction before putting a trade on to bet on this stock.