Well, it’s Friday, and for a change of pace, I’ve decided to tackle more of a “big picture” issue by looking at the unusual options activity for the Russell 2000 iShares ETF (IWM).
The IWM tracks the performance of the Russell 2000 Index, a collection of 2,000 small-cap stocks. As the FTSE Russell website states, these are “true” smaller companies, not mid-caps masquerading as small caps.
The index is the benchmark of 81% of the $1.67 trillion institutional money invested in small caps. If you’re not interested in smaller companies, IWM isn’t for you.
However, my initial observations tell me the markets are signaling it’s time to buy small-cap stocks.
Here’s why.
Note: Tomorrow, let’s all remember and honor the men and women currently serving or who have served at one time in our armed forces. Have an excellent weekend!
IWM’s Options History
The ETF’s 30-day average options volume is 1.75 million. As I write this Friday morning, the current put/call volume (P/C Vol) ratio is 2.14, while the put/call open interest (P/C OI)ratio is 1.56. Earlier this morning, the put/call volume ratio was well over 4.0 when I contemplated a story angle.
On Friday, at least, the markets seem to be bearish on smaller companies and IWM. Fair enough. However, if you look at the P/C OI ratio trend from about October 23, it’s steadily fallen from 2.02 down to 1.56 today.
So, while more put options remain open than calls, the differential is falling. Going back 24 months to October 2021, the only time the ratio’s been lower was Dec. 20, 2021, when it was 1.53. Its highest in the past two years was 3.32 on Aug. 22, 2022.
When the P/C OI ratio hit 1.53 in 2021, it was a two-month process (43 trading days) to get from 1.97 to 1.53. In this latest example, it’s taken just 14 trading days or one-third of the time.
I’m the farthest thing from an options wizard, but I can read trends, and this one screams it’s time to buy small caps.
The Other P/C OI Ratios
Before fully embracing my theory about small caps, I must examine the history of mid-caps and large caps over the past 24 months. That will tell me a lot about what’s happening in the markets.
I'll use the SPDR S&P MidCap 400 ETF Trust (MDY) as the proxy for midcaps. It tracks the S&P MidCap 400 Index. As S&P Dow Jones Indices points out, the index has an equity market cap equal to Canada’s total market cap. It represents approximately 5% of the U.S. equity market.
As I write this, the MDY P/C Vol ratio is 1.29, and the P/C OI is 0.59, suggesting that investors are generally far more bullish about mid-cap stocks than small caps on this day.
Going back 24 months, the lowest ratio was 0.33 on July 19, 2022. That’s a bullish sign. It stayed under 0.40 for eight consecutive days that July. The highest ratio (bearish) was 10.31 on Nov. 23, 2021. MDY hit an all-time high earlier that November and fell 24% over the next seven months.
Over the past three months, its P/C OI has stayed in a tight range between 0.43 and 0.78. If anything, the ratios moved higher, suggesting the clamoring for mid-caps is subsiding. There is no bullish trend in recent weeks.
The proxy for the S&P 500 is the SPDR S&P 500 ETF Trust (SPY). It is the oldest and largest ETF in America. Year-to-date, it’s up 14.6%, considerably better than 0.3% for MDY and -3.4% for IWM.
SPY’s P/C Vol and P/C OI ratios are bearish today at 1.72 and 1.82, respectively. Over the past 24 months, the high and low for P/C OI were 1.79 (Feb. 18, 2022) and 0.75 (Dec. 16, 2021).
Generally, the P/C Vol ratio is higher than 1.0 because the volume of put options on index-based ETFs is historically higher than the volume of call options due to hedging done by buy-side portfolio managers. So, at least for ETFs, it’s not an excellent barometer of sentiment.
As for the SPY P/C OI ratio, it’s gotten more bullish since the end of September, but nothing to write home about.
The Bottom Line
I've demonstrated that the P/C OI ratio for IWM is trending in a positive direction compared to both MDY and SPY. That tells me that investors are warming to small-cap stocks.
And, lo and hold, Barron’s has an article today entitled Small-Cap Stocks Have Had a Rough Year. It’s Time to Buy.
“Valuations indicate the S&P 600 has plenty of room for gains as long as the profit outlook improves. The index trades at about 12 times expected EPS for the next 12 months, a 34% discount to the S&P 500’s 18.2 times,” wrote Barron’s contributor Jacob Sonenshine.
“That gap, among the steepest over the past decade, is a signal that small-caps are worth a look. When smaller companies are in favor, the index can trade at a valuation in line with the S&P 500’s.”
Since we’re discussing unusual options activity, I’ll leave you with a possible play.
The Dec. 20/2024 $168 call has an ask price of $17.25. That’s a 10% down payment on 100 IWM shares currently priced at $167.74. There isn’t much volume -- 2o calls to open interest of just 4 for a Vol/OI ratio of 5.0 -- but the shares have 406 days to expiration, so there’s plenty of time (maybe too much time) for IWM’s share price to move higher than $185.
Just a thought.
On the date of publication, Will Ashworth did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
