Small-cap stocks, represented by the Russell 2000 index (RUT), have been on a tear recently, and options traders are taking notice. A surge in demand for bullish call options tied to the Russell 2000 and its corresponding exchange-traded fund (ETF), the iShares Russell 2000 ETF (IWM), suggests that investors are increasingly optimistic about the near-term prospects for small companies.
This bullish sentiment echoes a similar pattern observed in late 2023. Back then, a spike in call options activity coincided with a small-cap rally fueled by anticipation of aggressive interest rate cuts by the Federal Reserve. The Russell 2000 enjoyed a stellar performance, surging over 20% between November and December, significantly outpacing both the S&P 500 (SPX) and the Nasdaq Composite (COMP).
However, Mandy Xu, head of derivatives-market intelligence at Cboe Global Markets, cautions against complacency. “We saw this in [the fourth quarter] last year when bullish sentiment in small caps hit an extreme, though ultimately, the trade faded as rate-cut bets were pared back. Will it be different this time?” Xu ponders in her commentary.
Key Takeaways
- Bullish Options Activity: Demand for call options on the Russell 2000 and IWM has surged in recent trading sessions, pushing these contracts to a premium compared to bearish puts. This indicates a rise in investor optimism regarding the near-term performance of small-cap stocks.
- Echoes of Late 2023: The current options activity mirrors a similar trend observed in late 2023, preceding a strong small-cap rally fueled by expectations of Fed rate cuts.
- Outperformance: The Russell 2000 has outperformed the broader market recently, with its best four-day performance since 2020. It’s also on track to close at its highest level since January 2022.
- Open Question: Whether the current bullish sentiment translates into a sustained rally remains to be seen. Market watchers like Xu urge caution, highlighting the potential for a repeat of the short-lived rally witnessed in late 2023.
Heavy Call Option Volume
The options market is buzzing with bullish activity. Trading volume for calls tied to both the Russell 2000 and IWM reached multi-year highs on Thursday. For IWM, this translates to nearly 2.1 million calls changing hands, marking the highest daily volume since December 2009 and the sixth-highest on record dating back to 2005. Call options directly linked to the index itself haven’t seen such high volume since 2021.
This surge in call option activity coincided with the Russell 2000’s best performance since November. The index soared after a softer-than-expected inflation reading on the June Consumer Price Index (CPI) report. This rekindled hopes of a Fed rate cut in September, potentially boosting small-cap stocks.
Outperformance and Record-Setting Volume
The Russell 2000’s recent outperformance has been nothing short of impressive. Compared to the S&P 500, it has delivered its strongest relative showing since March 2020, when the COVID-19 pandemic roiled global markets. Over the past four sessions, the index has gained a robust 7.7%, putting it on track for its best four-day stretch since 2020. It’s also poised to close at its highest level since January 2022.
The elevated call option volume has persisted since Thursday. Trading activity in call options linked to the IWM ETF has remained more than triple the two-year daily average for the past three trading days. Additionally, the call-put volume ratio, a gauge of bullish calls versus bearish puts, has stayed above its historical average.
Looking Ahead
The recent surge in bullish call options activity on the Russell 2000 and IWM paints an optimistic picture for small-cap stocks in the short term. However, the question of whether this translates into a sustained rally remains unanswered. The historical precedent from late 2023 serves as a reminder that euphoria can fade quickly, especially if economic conditions or Fed policy expectations change.
Investors should closely monitor economic data releases and Fed pronouncements to gauge the sustainability of the current bullish sentiment.
