Rare Bullish Signal for Small-Cap Stocks from Options Traders

The demand for bullish call options linked to the Russell 2000 has soared, significantly outpacing the demand for bearish puts. This trend sends an optimistic signal to small-cap investors.

Mandy Xu, head of derivatives-market intelligence at Cboe Global Markets, reports that recent sessions have seen a notable rise in call option demand tied to the Russell 2000 and its corresponding ETF. This surge has pushed these contracts to trade at a premium over bearish puts, suggesting that the small-cap rally could continue in the near term.

Xu noted a similar pattern in late 2023, when investors boosted stocks expected to benefit from aggressive Federal Reserve interest rate cuts. At that time, the Russell 2000 rallied over 20% from early November to early December, outperforming the S&P 500 and the Nasdaq Composite, according to FactSet data.

“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 commented in an email.

Call options grant traders the right to buy shares of the underlying stock or ETF at an agreed-upon price before they expire, while put options allow traders to sell. Option contracts tied to an index are usually settled in cash.

On Thursday, trading volume for calls tied to both the Russell 2000 and the iShares Russell 2000 ETF (IWM) reached their highest levels in years, as reported by Dow Jones Market Data. Nearly 2.1 million calls tied to the ETF were traded that day, marking the highest daily turnover since December 2009 and the sixth-highest on record since 2005. Call options directly linked to the index saw their highest volume since 2021.

Thursday also marked the Russell 2000’s best session since November. Small-cap stocks soared following a softer-than-expected inflation reading from the June CPI report, reviving expectations of a Federal Reserve interest rate cut in September.

The Russell 2000 outperformed major indices like the S&P 500 and the Nasdaq, showing its most significant outperformance since March 2020 when the COVID-19 pandemic initially impacted global markets, according to Cboe data.

Over the past four sessions, the Russell 2000 has gained 7.7%, on track for its best four-day streak since 2020, according to Dow Jones Market data. The index is poised to finish at its highest level since January 2022.

Demand for bullish call options has remained elevated since Thursday. Trading volume in call options tied to the iShares ETF has been more than triple the daily average from the past two years on both Friday and Monday, according to market data.

The call-put volume ratio, which compares activity in bullish calls to bearish puts, has also stayed above average.

On Monday, the Russell 2000 was up 2.1% at 2,194, while the S&P 500 was up 0.1% at 5,619. The Nasdaq also saw a 0.1% increase to 18,415. Meanwhile, the Dow Jones Industrial Average (DJIA) was up 157 points, or 0.4%, at 40,281.