Wall Street is increasingly concerned about the options-driven momentum trade that helped push the S&P 500 into record territory.
With demand for bullish call options at its highest level in years, some analysts have set their sights squarely on NVDA Corp.
Wednesday's earnings report warns that it may be the catalyst that caps this trade, potentially reversing much of the market's rally over the past four months.
Their reasons are rooted in the fact that investors have become too nervous about risky options bets, and the mere fact that an earnings report is out could be enough to sink major US stock market indexes due to the internal dynamics of the options market – even if Nvidia's results satisfy Wall Street expectations. , according to several derivative markets experts who spoke with MarketWatch.
According to FactSet, analysts expect Nvidia to report earnings per share of $4.59, up more than 700% from the same quarter last year.
be seen: Nvidia may shine again when it announces on Wednesday
Traders are piling into bullish options at the fastest pace since the 2021 meme stock craze
As stocks have soared over the past year, surprising many on Wall Street, investors have increasingly relied on options to chase the market higher and boost returns.
This has caused demand for out-of-the-money bullish calls on the largest U.S. stocks to approach the most skewed level since the meme stock craze of 2021, according to data from Cboe Global Markets, one of the largest options exchange operators. .
An option is said to be traded “out of the money” when the strike price of the option is above or below where the underlying stock or index is traded, in the case of calls, or below it, in the case of puts.
In the options market, “skew” typically measures the demand for out-of-the-money calls compared to out-of-the-money calls, or the demand for out-of-the-money calls or calls compared to out-of-the-money calls. -Counterparts of money. In this case, it is the former.
CBOE Global Markets
One key difference between the era of meme stocks and the latest options market craze is that this time, more movement is happening in stocks that are heavyweights in the major market indexes, said Michael Lebowitz, a portfolio manager at the RIA. Advisors.
“Options buyers are usually more buyers of insurance. But now they've become more speculators, and that's what the skew tells you,” he said during an interview with MarketWatch.
Nvidia's earnings could be a make-or-break moment for the market, but the odds are stacked against the chip maker, said Michael Cramer, a longtime independent stock market analyst and founder of Mott Capital.
“The market, in my opinion, has made a big bet on one company,” Cramer said. “If Nvidia doesn't progress significantly, what's going to keep this thing going?”
With the stock already up about 50% this year, Nvidia has contributed about 25% of the S&P 500's 4.9% advance since the start of 2024, Cramer said.
As of Thursday, Nvidia's deviance reached its highest level since June, according to data from SpotGamma, which provides data and analysis on the derivatives market.
Most of the stock's progress over the past few months has been driven by aggressive buying, which has forced options market makers to scoop up shares of the underlying stock to hedge their positions, Cramer said.
Rally poised to reverse after Nvidia earnings
While Nvidia has become the poster child for momentum trading, plenty of other stocks have followed its path. For this reason, Brent Koshuba, founder of SpotGamma, believes the broader market could pull back next week, along with Nvidia, as bullish call options tied to a host of major US companies are likely to decline after the chipmaker reports earnings.
Kochoba explained that once Nvidia's earnings report is released, implied volatility across the options market will likely decline. This would be a typical reaction: Implied volatility rises when investors see potential market-moving events in the future that they want to hedge against, or speculate on. The opposite often happens when these market events occur.
As implied volatility declines, options will become cheaper, while allowing market makers who sold them to unload some of the equity they had accumulated to hedge their positions.
“Anything with a significant call skew could feel more selling pressure” following Nvidia’s reports on Wednesday, Kochuba said in a note to clients shared with MarketWatch.
Options market makers typically buy stocks or index futures to hedge their positions, because if the option goes into the money, they could be on the hook to deliver the underlying stock.
A lot of other technology names are seeing a heavy call option skew as well, especially semiconductor names like Advanced Micro Devices Inc. AMD,
and holding arm ARM,
In addition to other major technology giants such as Microsoft Corp. MSFT,
Traders are betting that Nvidia's rising tide could lift the broader IT sector.
Many on Wall Street, including Cramer, were uncomfortable with the role the options market played in pushing the broader market higher since October, especially as investors curbed their expectations about the number of interest rate cuts by the Federal Reserve this year. Earnings outside of a few big tech names were generally lackluster, Cramer said.
The rapid market advance has stocks trading at their highest levels compared to their expected earnings in more than two years, with major stock indexes such as the S&P 500 and Nasdaq-100 reaching record highs, while Wall Street analysts' forecasts for corporate earnings and growth in 2024 have declined.
The S&P 500's ratio to its expected full-year earnings exceeded 20 points for the first time since early 2022, according to FactSet data, rising above their five-year and 10-year averages.
The Nasdaq-100 NDX forward price-to-earnings ratio is even higher, trading north of 26 on Friday.
“Stocks don't trade on earnings momentum. They trade on multiple expansions,” said Mott Capital's Cramer.
Momentum begets momentum
Of course, just because momentum helped push stocks higher, doesn't mean traders can easily profit by betting that momentum will reverse imminently. As is often the case on Wall Street, momentum usually begets momentum.
“The pace of these rallies isn't really sustainable — and in the case of something like Nvidia, it sets a very high bar to hold up earnings — but the timing when momentum fades is always the hard part,” said Brett Kenwell, of US Options. Investment Analyst at eToro.
US stocks closed lower during the final trading session of the week, with the S&P 500 SPX and Nasdaq Composite COMP snapping a five-week winning streak. Dow Jones Industrial Average DJIA,
On the other hand, he was able to extend his winning streak to the sixth week in a row.
Aside from Nvidia's earnings, next week's calendar of potentially market-moving events looks very light, aside from the release of minutes from the Fed's January meeting.
