Connecting the Dots Between Small-Cap ETFs and Meme Stocks

Small-cap options traders are off their earlier summer highs

Managing Editor
Aug 20, 2021 at 9:31 AM
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Late last month, Schaeffer's Senior V.P. of Research of Todd Salamone revisited the bears flocking to components of the iShares Russell 2000 ETF (IWM). The exchange traded fund of the Russell 2000 Index (RUT) was declining, while put traders were gaining courage. Fast forward two weeks, and the same ratio discussed by Salamone is worth revisiting, albeit with a different lens and context.

The latest put/call ratio reading of the IWM shows that after hitting those six-month highs referred to above, it has declined, sharply, to roughly 0.351, per the chart below supplied by Schaeffer's Senior Market Strategist Chris Prybal {For reference, a 0.351 reading implies nearly three times as many calls bought-to-open as puts, over the previous ten trading days.} That sudden decline is interesting in its own right, yes, but much more capable minds such as Salamone are better fit to tackle the discrepancies.

Instead, let's focus on what exactly is composed of the IWM and small-caps. Per Newsweek and Bloomberg, the meme stocks that have shaken up the investing world in the last 18 months have become heavy hitters in the IWM/RUT. AMC Entertainment (AMC) is the ETFs largest holding. So while the small-cap sphere is far more encompassing than just Reddit darlings – the sector with the most exposure is healthcare. Does this mean there is a renewed run at meme stocks brewing, as put traders hit the exits?

COTW IWM

The chart below supplied by Prybal tests this theory. This put/call ratio is comprised of all the high-profile tickers that fit the meme profile. It's a veritable who's-who of champions from the Reddit forums; AMC Entertainment (AMC), GameStop (GME), Clover Health (CLOV), Palantir (PLTR), among others. As you can see, the ratio hit a short term peak of 0.5 on July 19 and has since turned lower to 0.352 upon Thursday's close.

You can also see there's not much correlation between the meme list and the Nasdaq-100 (NDX). Sometimes the two are rising in concert, like earlier in the summer. Other times, like mid-July, the two are running headfirst into each other. But what you can glean from the chart is the 0.3 area represents a floor that was tested back in April, and once again in late June to early July.

COTW Meme pc ratio

Both charts indicate IWM and meme put trading is on the quieter side. It's probably not a coincidence that at the same time these sentiment readings churn, the National Association of Investment Managers (NAAIM) exposure index is at its most elevated point since June.

So despite all of the hand-wringing about the delta variant, or bubbling inflation, investor optimism is running rampant. As the charts show, its especially with among small caps and meme stocks; two entities that could be construed as the catalysts behind this current market environment. In the case of an equity-based ETF like IWM, falling demand for put options could be the result of less demand for the shares among hedged players, who buy puts to offset their long equity exposure. And now certainly seems like an opportune time, considering IWM's 30-day at-the-money (ATM) implied volatility (IV) of 20.8% ranks in the 9th annual percentile, meaning short-term options premiums are pricing in relatively low expectations at the moment. As contrarians, that should give you pause.

Subscribers to Schaeffer's Chart of the Week received this commentary on Sunday, August 15.

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