Wall Street Concerned About Options-Driven Momentum Trade as Nvidia Earnings Loom
As the S&P 500 index continues to reach record highs, Wall Street is becoming increasingly concerned about an options-driven momentum trade that has played a significant role in driving the market’s rally. Analysts are now turning their attention to Nvidia Corp.’s upcoming earnings report, suggesting that it could be the catalyst that brings this trade to a halt and potentially reverses the market’s recent gains.
The concern stems from the fact that investors have become heavily reliant on risky options bets, and the mere passing of Nvidia’s earnings report could have a significant impact on the internal dynamics of the options market. Even if Nvidia’s results meet Wall Street’s expectations, the surge in bullish call options could potentially sink the main U.S. stock-market indexes.
Over the past year, as stocks rallied unexpectedly, investors turned to options to chase the market higher and boost returns. This has led to a surge in demand for bullish out-of-the-money calls on major U.S. stocks, reaching levels not seen since the meme-stock craze of 2021. The skew, which measures demand for out-of-the-money calls compared to puts, is currently skewed towards calls.
One key difference between the current options-market frenzy and the meme-stock era is that this time around, more of the action is taking place in stocks that heavily influence the main market indexes. This shift from insurance buyers to speculative traders has raised concerns among experts who believe that the market has placed a significant bet on one company, Nvidia.
Nvidia’s earnings report is seen as a make-or-break moment for the market, with many analysts suggesting that the odds are stacked against the chipmaker. With Nvidia’s stock already up nearly 50% this year, it has contributed to a substantial portion of the S&P 500’s recent advance. The skew in Nvidia reached its highest level since June, indicating the aggressive call buying that has driven the stock’s rally.
While Nvidia has become the poster-child of the momentum trade, other stocks have also benefited from this trend. As a result, Brent Kochuba, founder of SpotGamma, believes that the broader market could decline alongside Nvidia after its earnings report. The cheapening of bullish call options tied to major U.S. companies is expected once Nvidia’s report has passed, leading to a decline in implied volatility across the options market.
Options market makers typically buy stocks or index futures to hedge their positions, and the decline in implied volatility would allow them to dump some of the stocks they accumulated. This selling pressure could affect other technology names with extreme call option skew, such as Advanced Micro Devices Inc., Arm Holdings, and Microsoft Corp.
Many on Wall Street have expressed unease about the role of the options market in driving the broader market higher. Despite lackluster earnings outside of a few megacap technology names and reduced expectations for interest-rate cuts by the Federal Reserve, stocks continue to trade at rich valuations relative to their expected earnings. The market’s torrid advance has been driven by multiple expansion rather than earnings momentum.
While momentum has played a significant role in propelling stocks higher, it is challenging to predict when this momentum will fade. Timing the reversal of momentum is always a difficult task for traders. Despite concerns, the Dow Jones Industrial Average managed to extend its winning streak for a sixth straight week, while the S&P 500 and Nasdaq Composite snapped their five-week winning streaks.
Looking ahead, aside from Nvidia’s earnings, next week’s calendar of potentially market-moving events is relatively light, with the release of minutes from the Fed’s January meeting being the main highlight.
In conclusion, Wall Street’s growing unease about the options-driven momentum trade and Nvidia’s upcoming earnings report highlights the potential risks associated with relying heavily on risky options bets. The surge in bullish call options has raised concerns about the internal dynamics of the options market and the potential impact on the broader market. While momentum has driven stocks higher, timing the reversal of this momentum remains a challenge. Investors will be closely watching Nvidia’s earnings report and its implications for the market’s rally.