“Small caps are possibly the largest range as measured by the iShares Russell 2000 ETF (IWM – 190.30) and the Russell 2000 Index (RUT – 1,911.69). With IWM and SPY performing roughly the same in 2020, there is much greater short-covering potential in small-cap stocks compared to large-cap stocks. ”
– –Monday morning outlook, December 14, 2020
After the stock exchanges released short interest data for the end of 2020 last week, I was reminded of the comments I made in mid-December, as shown above. Given the moves we’ve seen in many individual stocks over the past few weeks, I feel like we’ve seen major short-covering rallies in the small-cap space since I made those comments in mid-December.
According to the table below, this has resulted in significant outperformance in exchange-traded small-cap equity funds (ETFs) compared to higher capitalization ETFs like the technology-driven Invesco QQQ Trust Series (QQQ – 311.86) or the broader SPDR S&P 500 ETF Trust with high market capitalization (SPY – 375.70).
“How do you play this environment? First, options can be used in place of stocks to lower the risk of dollars, but the leverage can work for you in case you play up stocks that may bounce … “
– –Monday morning outlook, December 21, 2020
In fact, one of the few strategies I’ve recommended over the last month is to use call options as a substitute for stock games in recognition of bullish price action given the sentimental risk, emerging headlines about Covid-19 vaccines, and new stretch uncertainties. Call options allow you to reduce the dollars you invest, define your risk, and leverage gives you attractive opportunities for profit.
With this in mind, many of our subscribers benefited directly from the short-term small-cap advance and made huge profits at GameStop (GME), Bed Bath & Beyond (BBBY), SunPower (SPWR) and Under Armor (UA). , Shake Shack (SHAK), and Axon Enterprises (AAXN) calling options.
If short coverage continues, small-cap stocks should continue to have the best chance in the coming weeks.
While the components of the S&P 500 Index (SPX – 3,768.25) had short coverage that is likely to support the index for pullbacks, overall short interest is at a multi-year lows. Additionally, looking at names with large-cap technology, measured by brief interest in QQQ components, can fight headwinds as brief interest grows from a multi-year lows.
Meanwhile, short interest in components of the Russell 2000 Index (RUT – 2,123.20) is decreasing. From a broader perspective, overall short interest in its components is closer to multi-year highs, which leaves significant room for activity to be covered. Whether you are using call options to speculate on individual stocks or to split stock investments between small caps or large caps, make sure you give the small cap space focus.
“… despite the headlines some of which may make the bulls pause, the SPX has never crossed the 20-day rising moving average, which is below the first level of potential pullback support, the 2020 closing price of 3,756, 07. “
– –Monday morning outlook, January 11, 2021
Before the long weekend, everything withdrew on Friday, whether large cap, technology or small cap. Although high-profile banks reported profits well above expectations and President-elect Joe Biden released his stimulus plan on Thursday evening, buyers were nowhere to be found.
However, the SPX’s retreat last week can hardly be defined as a retreat that would panic among traders who have been extremely bullish over the past few weeks. Friday’s SPX low was indeed around the 20-day moving average, which is now around the 2020 close of 3,756, which I identified as the index’s first potential level of support last week.
The CBOE Market Volatility Index (VIX – 24.34) rose slightly last week, but Wall Street’s “fear indicator” still does not indicate great volatility as it remains well below its 252 day moving average. In addition, the first 100% yoy increase in this index in the first area in the chart below acted as a “resistance point”, which has been the case since mid-December.
Looking towards the end of the month, that 100% year-over-year gain in the VIX when it comes into play will follow a surge into the 36 area around this time in November like last year just weeks after China announced that a novel virus had emerged in the country rose from 12 to 18.
One thing we don’t see right now compared to that time last year is the emergence of a significant number of VIX call buyers versus put buyers according to the graph immediately below. These call buyers turned out to be predictive about their timing over the past year as VIX calls purchased at a rate of four to one compared to puts over the past 20 days. Currently this ratio is only 1.35.
Finally, one (or all) of the following strategies are still recommended:
- Use calls instead of stocks to manage sentimental risk, but also play the current trend higher.
- Use straddles – buying a call and put at the same time – for the same reason you did with the first bullet (and to manage the risk of returns).
- Unless you are using call options as a stock substitute, consider index puts to hedge long stock positions.
- Emphasize small-cap stocks versus large-cap stocks.
Todd Salamone is Schaeffer’s Senior VP of Research