Investors haven't been this bullish since the peak of the 2021 meme-stock frenzy, according to this chart

By Joseph Adinolfi

'FOMO' may be driving investors to pile into 'out-of-the-money' call options

Investors are bullish on stocks.

By one measure, investors haven't been this bulled up on stocks since the heady days of the original meme-stock frenzy back in 2021.

On Monday, strategists from Cboe Global Markets shared a chart with MarketWatch showing that investors have been aggressively piling into "out-of-the-money" call options. The surge has coincided with a surge in options trading by retail investors, according to data from Citadel Securities.

A call option gives the holder the opportunity, but not the obligation, to buy a given stock at a stated price - known as the strike price. An "out of the money" call option has a strike price higher than where the underlying stock is currently trading. They tend to be cheaper than "at the money" options, while offering investors the chance of a greater return if the bet pans out. An "at the money" option has a strike price right around where the underlying is currently trading.

As a result, the share of the top 100 stocks on the S&P 500 with an inverted three-month call skew has surged past 20%, reaching its highest level since early 2021, when the rise of original meme stocks like GameStop and AMC helped inspire a frenzy of options trading among investors still stuck at home during the COVID-19 pandemic.

What's skew?

The options market was created as a tool for investors looking to protect their portfolios from drawdowns. As a result, put options, which help to offset losses, typically trade at a premium to similar call options. The same is true for so-called "at the money options." They typically trade at a premium to "out of the money" options, since the further away from the money an option is, the less likely it is to deliver a payoff.

When demand for "out of the money" calls is much stronger than demand for "at the money" calls, the so-called "call skew" tends to invert. Options-market experts have said this is a sign that "FOMO" might be driving investors to pile into trades that have recently performed well. According to SpotGamma, much of this crowding has occurred in options tied to hot semiconductor names.

See: The options market is flashing an ominous sign about Nvidia's looming earnings

When sentiment reaches extremes, it can sometimes signal that the market might be reaching a tipping point. A crowded trade could be about to slam into reverse.

U.S. stocks looked set to open lower on Tuesday. If the S&P 500 SPX finishes lower, it will mark a third-straight day in the red - the longest losing streak since March.

-Joseph Adinolfi

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