By Saqib Iqbal Ahmed
NEW YORK (Reuters) -A wave of bullish options trading has amplified the U.S. stock market’s advance toward another major milestone and left dealers positioned so that market swings are likely to be exaggerated in coming days or weeks, according to options specialists.
The S&P 500’s 17% rally this year to record highs has brought the index close to the 7,000 mark, accompanied in recent weeks by a surge in bullish options activity.
Strong demand for call options earlier this month pushed the one-month rolling calls-to-puts traded ratio to its most bullish level in roughly four years, according to a Reuters analysis of Trade Alert data.
Calls convey the right to buy stock at a set price in the future, while holders of puts can sell at a later date.
“People really front-ran this whole move into this 7,000 area,” said Brent Kochuba, founder of options analytic service SpotGamma.
The rush into upside call options has left options dealers as net sellers of options – a stance known as “short gamma,” options specialists said.
Dealers generally aim to maintain market neutrality. In a short gamma position, they typically sell stock futures during market declines and purchase them during rallies, intensifying price movements in both directions.
“On our trading desk we are seeing more extreme upside call buyers, so it makes sense that the market makers of the world would be short gamma,” Chris Murphy, co-head of derivative strategy at Susquehanna Financial Group, said.
This dynamic suggests that if the S&P 500 climbs above 7,000, the rally could receive additional momentum from options dealers’ hedging activity.
TWO WAY MARKET
However, short gamma positioning carries risks in both directions, analysts warned.
Any decline in the benchmark index could similarly be exacerbated by derivatives-related trading as options dealers sell stock futures into a weakening market.
“The problem now is people own expensive calls and there’s not that fuel for the next leg higher at this moment,” Kochuba said, adding he would not be surprised to see the market pull back from current levels.
The rush by investors into upside calls on the so-called Magnificent Seven of the largest and most influential technology-focused companies has “locally peaked-out,” Nomura strategist Charlie McElligott said. The companies are Apple, Amazon, Alphabet, Meta Platforms, Microsoft, Nvidia and Tesla.
McElligott sees a “window for a 3% to 5% pullback” in U.S. stock indexes in the next few weeks, he said in a note on Thursday.
On Thursday, the S&P 500 and the Nasdaq lost ground as Meta and Microsoft slid on concerns of surging artificial intelligence spending, adding to concerns about the pace of monetary policy easing from the U.S. Federal Reserve.
(Reporting by Saqib Iqbal Ahmed; Additional reporting by Laura Matthews and Shashwat Chauhan; Editing by Alden Bentley and Richard Chang)
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