It may be time for Big Tech’s wake-up calls

Megacap tech companies are showing some signs of stirring as their quarterly reporting period begins.

On the eve of Tesla and Alphabet’s earnings, a Bloomberg index that tracks the so-called Magnificent Seven (Microsoft, Apple, Nvidia, Alphabet, Amazon, Meta, and Tesla) rose 2.3% on Monday in its best day of the month. The prior 8% pullback in this cohort is – in the grand scheme of its +40% year-to-date gain – a flesh wound. 

But what’s concerning for investors looking for a repeat of the group’s performance in the back half of the year is how much demand for bullish options has plummeted.

On Monday, the total call volumes traded across the group totaled 4.1 million, the lowest in over a year. That’s down from a cumulative 14.1 million on June 7 – the session before Nvidia’s stock split went into effect. 

The decline in call buying is more acute in Nvidia – off more than 80% over this period. But five members of the Magnificent Seven have seen call volumes decline by at least 20% over this stretch – Amazon and Alphabet are the exceptions, where demand for bullish options has risen. This period has been marked by something of a “hot potato” dynamic in the options market, with speculative activity shifting from Nvidia after its split to Apple, to Tesla, and then to small caps.

Why does this matter? Because call buying can magnify demand for a stock. Assume a world in which a trader buys a call option, and a dealer is on the other side of the trade. The dealer is on the hook if that stock goes up enough so that the option is money-good. Dealers don’t like taking directional risk – they like making money on the fine edges of every trade. So, dealers will offset that directional exposure by buying the underlying stock. Problem solved – and more effective buying demand for that company’s shares. The positive momentum created during times of heavy call buying can, at times, resemble something of a perpetual motion machine (it isn’t, though). 

Earnings are certainly a potential catalyst for (most of) the Magnificent Seven to be able to remind investors why they warrant such an honorific.

Per John Butters, senior earnings analyst at FactSet, four of the seven constituents– Nividia, Amazon, Meta, and Alphabet – are expected to be among the top five drivers of annual earnings growth for the S&P 500 this reporting period. Profit growth by these four companies is expected to outstrip the rest of the index by 50 percentage points, according to Butters, and that premium performance doesn’t shrink to less than 15 percentage points until the fourth quarter.

Microsoft, Meta, Apple, and Amazon will release their quarterly figures next week, while Nvidia’s report is still more than a month away.

Perhaps call demand will pick up in the next few sessions as investors pre-position for financial results that tend to exceed expectations. Or, on the other hand, given the amazing run of form for these stocks so far this year, there’s a higher bar to clear for traders to aggressively re-engage in these names.

In the long term, stocks are going to be driven by earnings growth. But shorter-term episodes of outperformance in stocks or sectors are often going to include a substantial amount of multiple expansion. And that’s a process that is usually firmly rooted in flows, and more and more, those flows tend to be emanating from the options market.