S&P 500 Stocks With the Strongest Demand for Bullish Options Continue to Outperform

The surge in demand for options contracts has mirrored the stock market's rally this year, with both professional and retail traders eagerly engaging in bullish bets on individual stocks at a pace reminiscent of the meme-stock craze. Data from Cboe Global Markets reveals this trend, indicating a notable increase in options trading activity.

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Citigroup's equity strategists examined the correlation between heavy call buying and stock-market returns, discovering that a group of 50 companies with the highest demand for bullish options has outperformed the S&P 500 since the onset of the COVID-19 pandemic. According to Citi's data, spanning from December 2018, this group of popular options plays has surpassed the S&P 500 by 7 percentage points.

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Call options provide the holder with the right, but not the obligation, to buy the underlying asset at a predetermined price within a specified time frame. In contrast, puts grant the right to sell. While both options can serve as hedging tools, calls are commonly used for bullish bets, while puts are employed for bearish expectations.

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The Citi team, led by Stuart Kaiser, Citi's head of U.S. equity trading strategy, emphasized that the observed trend does not necessarily prove that demand for bullish options directly leads to outperformance. However, they deemed the relationship noteworthy, particularly in the context of the significant increase in options trading activity, particularly by retail investors, in the post-pandemic era.

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The strategists noted, "An important characteristic of financial markets in the postpandemic era was the significant increase in options trading activity, particularly by retail investors. These flows were skewed towards calls, and were largely concentrated in a select group of stocks. We find these stocks with high call volumes notably outperformed the broad market in the early years of the pandemic."

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While establishing a direct causality in this relationship is challenging, the Citi team considers it an essential metric for investors, especially given the uptick in options volumes. February stood out as a particularly active month for options traders, marked by increased bullish bets leading up to Nvidia Corp.'s latest earnings report. According to Citigroup, the demand for options on individual stocks reached its highest level since January 2022 last month.

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On Tuesday, U.S. stocks experienced a decline, with the S&P 500 down 0.9% at 5,086, and the Nasdaq Composite dropping 1.5% to 15,960. Nvidia Corp., whose options ranked as the most heavily traded based on the total value of the underlying shares each contract controls, was down 0.1% in recent trade at $852 per share. As the market navigates these dynamics, the intersection of options trading and stock performance continues to capture the attention of investors and market observers alike.

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