Small-Cap Stocks Show Potential as Tech Dominance Wanes

Buying dips and selling rips has been the name of the game in the S&P 500 all summer.

Options action suggests that it can continue, with VIX at recent lows and a slowdown in the wild speculative call-buying in tech that was pulling the market quickly in both directions. To an extent, that's just the summer standard. But with the market so lopsided to tech, traders are waiting on that group for direction.

For small-cap stocks, it could be an opportunity. As the mighty Nasdaq-100 runs in place, the Russell 2000 is steadily pushing higher, now up 20% this year versus the Nasdaq's 18% advance.

One of the biggest options trades in the entire market Thursday seems to suggest small caps might lead the next move up or down.

A trader in the Russell 2000 IWM ETF spent almost $20 million on a position that benefits from a big move in either direction, with a slight bias to the downside. The trader spent $11 million buying 15,000 of the 270-strike puts expiring in mid-December, as well as $7 million of the same number and expiry of the 335-strike calls.

The trade, known as a strangle, makes money if the small-cap ETF either rallies 14%, or drops 11%, by Dec. 18.

"It could be the bloom is off the rose and there's finally exhaustion in mega-cap tech stocks," said Eric Kuby, chief investment officer at North Star Investment Management, a small-cap-focused mutual fund business in Chicago. "People are looking for other places to put their money, and I've seen some forecasts for higher than 20% earnings growth for small caps."

The Russell 2000's 21% rally in the second quarter was the eighth-biggest quarterly move in history and the strongest showing since 2020, according to an analysis by Strategas Research Partners.

Small caps have also fared well this year despite rising Treasury yields, often considered one of the group's Achilles' heels. Regional banks in the KRE ETF have gained 15% year-to-date compared to a 1% move in the S&P 500 financial sector.