Options traders are increasingly making riskier bets across the U.S. stock market, fueling a rally driven by fading election uncertainties and growing expectations of a Republican-controlled Washington next year.
The bullish activity spans a broad range of assets, from electric car maker Tesla (TSLA.O) to small-cap stocks and regional banks. These moves have contributed to the S&P 500’s 3% gain since the November 5 election.
Garrett DeSimone, head of quantitative research at OptionMetrics, commented, “We’ve got this relief from a major risk. It’s happening across the board... everything, except for bonds, is going up.”
Ahead of the election, options traders had taken a more defensive stance to hedge against potential volatility, including concerns over a delayed or contested election result.
Many traders are now shifting to a bullish outlook, concerned about missing out on a market rally following the anticipated victory of Donald Trump and the Republicans gaining control of both houses of Congress, a result projected by Edison Research on Wednesday. This outcome is expected to give Republicans more freedom to advance their economic agenda, including tax cuts and deregulation.
"Investors are panicking to chase stocks at all-time highs," said Charlie McElligott, managing director of cross-asset strategy at Nomura, in a note earlier this week.
According to data from Trade Alert, the volume of daily call options—those that profit when stocks rise—has surpassed puts by a ratio of 1.5-to-1, up from 1.3-to-1 for the rest of the year. Deutsche Bank also reported a significant increase in net call volume across single-stock options in most sector groups following the election.
The volatility landscape has shifted significantly, with the Cboe Volatility Index (.VIX), a key gauge of demand for portfolio protection, dropping to a near four-month low of 13.67.
Michael Thompson, co-portfolio manager at Little Harbor Advisors, explained, "What the volatility market was worried about didn’t materialize, so all that excess concern has been removed."
Charlie McElligott highlighted a surge in demand for call options across a variety of assets, including the iShares Russell 2000 ETF (IWM.P), ARK Innovation ETF (ARKK.P), SPDR S&P Regional Banking ETF (KRE.P), and VanEck Semiconductor ETF (SMH.O).
This shift from caution to optimistic speculation was particularly evident in Tesla options. Investors flooded into call options after the election, betting that CEO Elon Musk's strong ties to Trump could benefit the electric vehicle maker. Tesla options represented nearly 30% of the total U.S. stock options traded by notional value on Monday, according to Nomura data.
Analysts suggest that this rush into bullish options may be fueling the rally in stock prices. “When investors pile into calls, this information flows into the stock, and we see an increase in the stock itself,” said Garrett DeSimone of OptionMetrics.
TEMPERED OPTIMISM
The so-called "Trump trade" could face some volatility ahead as details of the timing and implementation of the Republican policy agenda become clearer. Investors are also cautious that elements of Trump's economic platform, such as tax cuts and tariffs, may lead to inflationary pressures.
These concerns have been reflected in the recent rise in Treasury yields, which could pose a challenge for stocks if the trend continues. Stocks dropped on Thursday after Federal Reserve Chairman Jerome Powell indicated that there was no immediate need for policy changes, given the strength of the economy. He also noted that the true impact of Trump's policies on economic growth won't be clear until new laws or administrative actions are passed or enacted.
This may explain why some measures of investor sentiment are still far from the euphoric levels seen in previous market rallies. For example, the S&P 500 skew, which tracks the relative demand for bullish calls versus bearish puts, has dropped to 4% from 7% just before the election, showing that investors have become less defensive. However, this figure has been even lower at times this year, such as in May, when it stood at 3%.
“This suggests that markets are maintaining some degree of caution rather than showing complete complacency,” said Garrett DeSimone of OptionMetrics.