Bullish derivative bets mesh with the buy-the-dip mentality, says IBKR's Sosnick
Options trading is at the root of volatility in memory-chip stocks.
The U.S. stock market sits just a fraction below record highs after another slide - on renewed AI valuation concerns - triggered an even faster rally, as chips and hyperscaler plays bounced.
Steve Sosnick, chief strategist at Interactive Brokers, seems wary of such knee-jerk rebounds, and argues that a shift in attitudes toward option trading may help explain them.
In commentary published Thursday afternoon, Sosnick notes the vigorous action in memory-chip stocks in recent days. Recall, these were at the center of the market's volatility over the past few weeks as they got caught in the blowup of the Situational Awareness hedge fund.
Shares of Sandisk $(SNDK)$ and Western Digital $(WDC)$ opened with double-digit percentage losses on Thursday after succumbing to a currently prevalent market trend: earnings and revenues that beat consensus estimates, but guidance that appeared to underwhelm the more enthusiastic investors.
But for Sosnick, "the bigger story is the intraday rallies that occurred in these stocks after significant initial shakeouts." He notes that Western Digital was down 21.5% at one point, but cut those losses to about 8.5%, while Sandisk fell 13.8% and at one point cut its losses to about 3%. (Both did fall back a bit more later in the day.)
A look at longer-term charts of Western Digital and Sandisk shows that despite being well off their peaks, both stocks have still had stellar returns but with volatility a constant factor. Even as both shares fell from their June highs, there were significant rallies during the downtrend.
Such moves, says Sosnick, show: "Dip buying remains a key source of activity, even if it results only in countertrend moves. To my mind, this is reflective of the overall approach to risk that has pervaded the general market mindset."
And that risk-seeking attitude is exemplified by the action in major index options, he believes.
Sosnick quotes a post on LinkedIn by Henry Schwartz, in which the vice president of market intelligence at Cboe examines trading in S&P 500 options. Such options give the buyer the right to purchase the index at a particular level within a specific time frame (a call option) or the sell the index under the same criteria (a put option).
Schwartz notes that as option-trading volume has exploded in recent years, there has been a sharp decline in the ratio of puts to calls, which "illustrates a dramatic change in user behavior compared to prior decades." In other words, option traders are becoming more bullish.
Indeed, Schwartz notes that earlier this week a record 4 million S&P 500 call options were traded, with a put-call ratio of 0.83, which he says is the second-lowest reading ever.
Sosnick says he is wary of placing too much emphasis on one statistic, but nevertheless argues that a near-record low put-call ratio is worthy of consideration as it shows that "it is indisputable that bullishness is quite well-ingrained in the market's mindset."
"This is reflected in the ever-shorter and ever-shallower dips in key indexes, and by the relatively violent reactions when good news justifies an upward revaluation," he adds.
Often, a low put-call ratio is a sign that investors are overly ebullient and can thus be seen as a contrarian indicator, presaging a market retreat. Sosnick is cautious about using the statistic to call a market top or turning point.
But he says: "I do think it's fair to note that we have seemingly changed our general perceptions about whether major index options are better utilized as tools for speculation rather than risk management."
"It is, of course, possible that this change does involve risk management, but the risks being managed are those of underperformance rather than concerns about losses," he adds.
The markets
U.S. stock-index futures (ES00) (YM00) (NQ00) are higher as Treasury yields BX:TMUBMUSD10Y dip. The dollar index DXY is little changed, as oil futures (CL.1) rise and gold futures (GC00) trade around $4,364 an ounce.
Key asset performance Last 5d 1m YTD 1y S&P 500 7709.96 3.66% 2.20% 12.63% 21.61% Nasdaq Composite 26,348.35 4.88% 0.54% 13.37% 24.03% 10-year Treasury 4.667 -7.30 10.50 49.50 38.10 Gold 4368.1 6.58% 5.79% 0.83% 26.31% Oil 77.25 -11.00% 8.03% 34.56% 21.94% Data: MarketWatch. Treasury yields change expressed in basis points
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