Wall Street Raises Concerns about Options-Driven Momentum Trade
Wall Street is growing increasingly uneasy about an options-driven momentum trade that has helped push the S&P 500 index into record territory.
Analysts Eye Nvidia Earnings Report
Market analysts pinpoint Nvidia Corp.’s earnings report as a potential catalyst that could slam the brakes on this trade, possibly reversing a substantial portion of the market’s rally over the past four months. Dampening the current bullish call options trend, several derivative-market experts have warned that the mere fact of the earnings report passing could impact the main U.S. stock-market indexes due to the internal dynamics of the options market, even if Nvidia’s results meet Wall Street’s expectations.
Analysts predict that Nvidia will report earnings per share of $4.59, reflecting a remarkable increase of over 700% from the same quarter last year.
Relentless Options Trading on the Rise
Over the past year, as stocks rallied unexpectedly, many Wall Street investors have increasingly turned to options to chase the market’s upward trend and boost their returns. As a result, demand for bullish out-of-the-money calls on major U.S. stocks has reached a level nearing the extreme reached during the meme-stock craze of 2021, according to data from Cboe Global Markets, one of the leading options-exchange operators.
Skew, a measure of the demand for out-of-the-money calls compared with out-of-the-money puts, is higher this time due to more action taking place in heavily weighted stocks in the main market indexes, as noted by Michael Lebowitz, a portfolio manager at RIA Advisors. According to Lebowitz, option buyers, who are typically more focused on hedging risk, have shifted towards becoming more speculative traders, as reflected by the current skew.
High Stakes: Nvidia Earnings as a Market Barometer
Wall Street experts, including Michael Kramer, a seasoned independent stock-market analyst and founder of Mott Capital, are expressing concerns about the overwhelming reliance on the options market to drive the broader market higher since October. With expectations diminishing for the number of interest-rate cuts by the Federal Reserve in 2024 and generally lackluster earnings outside of a few tech giants, the market’s record-breaking advance has left stocks trading at levels not seen relative to their expected earnings in more than two years. This highly inflated perspective, measured by the ratios and forward price-to-earnings, signifies that stocks are trading on multiple expansions rather than earnings momentum.
Implications on the Horizon
Market experts, as well as Brent Kochuba, the founder of SpotGamma, a company specializing in options market data and analytics, believe that the momentum-driven trade, with Nvidia at the forefront, could face challenges in the near term. Once Nvidia releases its earnings report, a decline in implied volatility across the options market is expected. This decline in volatility is likely to drive down option prices, prompting market makers to offload some of the stocks they accumulated to hedge their positions.
Additionally, other technology stocks, particularly semiconductor names like Advanced Micro Devices Inc. (AMD) and Arm Holdings, are also experiencing notable skew in the call option market. Similarly, major tech companies like Microsoft Corp. are riding the bullish trend, believing that Nvidia’s performance will uplift the broader information-technology sector. However, the precarious reliance on momentum creates an uncertain trading environment, as timing the end of the rally remains a challenge.
Market Performance
During the final trading session of the week, U.S. stocks closed lower, snapping five-week winning streaks for the S&P 500 and Nasdaq Composite. Conversely, the Dow Jones Industrial Average extended its winning streak to a sixth week. Looking ahead, besides Nvidia’s earnings, the upcoming week does not show many events that could significantly impact the market, except for the release of the Fed’s January meeting minutes.
