The demand for options contracts has surged along with the rally in stocks this year, with both professional and retail traders jumping into bullish bets on individual stocks at a rapid pace. This trend has been observed since the meme-stock craze, based on data from Cboe Global Markets.
Connection Between Call Buying and Stock Market Returns
A group of equity strategists at Citigroup have highlighted the strong correlation between heavy call buying and stock-market returns. They discovered that a selection of 50 companies showing the highest demand for bullish options has actually outperformed the S&P 500 ever since the start of the COVID-19 pandemic.
Since December 2018, this group of top options plays has outpaced the S&P 500 by 7 percentage points, as revealed by Citi’s data displayed in the chart below.
Understanding Call and Put Options
A call option provides the holder with the right (but not the obligation) to purchase the underlying asset at a predetermined price within a specified timeframe. On the other hand, a put option grants the right to sell. While both types of options can be utilized for hedging market trades, calls are commonly used for bullish bets, while puts are employed to speculate on price declines.
The Citi team noted that, although this trend does not definitively prove that the demand for bullish options directly leads to outperformance, they found the relationship to be significant.
Post-Pandemic Surge in Options Trading
In the aftermath of the pandemic, financial markets witnessed a notable surge in options trading activity, particularly driven by retail investors. Stuart Kaiser, Citi’s head of U.S. equity trading strategy, highlighted this trend in a recent report.
Concentrated Call Volumes
The increase in trading flows leaned heavily towards call options and was primarily focused on a select group of stocks. Interestingly, stocks with high call volumes significantly outperformed the broader market during the early stages of the pandemic.
Importance of Options Volumes
While establishing a direct causal link is challenging, the team emphasized the significance of this trading behavior as a crucial metric for investors amidst the uptick in options volumes.
Busy Month for Options Traders
February proved to be a particularly active period for options traders, especially ahead of Nvidia Corp.’s latest earnings report. Citigroup reported that demand for options on individual stocks surged to its highest level since January 2022 last month.
Market Update
- The S&P 500 (SPX) was down by 0.9% at 5,086.
- The Nasdaq Composite (COMP) experienced a 1.5% decline at 15960.
- Nvidia Corp. saw a slight dip of 0.1% in recent trade, priced at $852 per share.
