Analyst: Regardless of whether NVIDIA's earnings report is good or bad, it will put an end to the rising trend of US stocks.

The upcoming NVIDIA earnings report to be released this week may potentially reverse the strong upward trend in the U.S. stock market over the past 4 months.

As the S&P surpasses the 5000-point mark, analysts are warning that the NVIDIA performance report scheduled for Wednesday local time could put the brakes on the stock market rally.

Due to the ongoing AI frenzy this year, bets on high-risk call options have surged to the highest levels in years. Derivatives market experts have indicated that even if NVIDIA's fourth-quarter performance report meets market expectations, it could still drive major stock indices lower.

Surge in call options causing anxiety

Since last year, the U.S. stock market has been soaring, with investors increasingly relying on options trading to chase the market higher.

Data from the Chicago Board Options Exchange, one of the largest options trading operators globally, shows that the out-of-the-money demand for call options on high market cap stocks is approaching the most distorted levels since the meme stock craze in 2021.

For call options, when the strike price is higher than the market price, the option is referred to as out-of-the-money (OTM), indicating a strong bullish sentiment in the market, especially towards heavyweight stocks.

However, against the backdrop of converging rate cut expectations and underwhelming performance of tech giants, the market rally driven by the options market since October last year has left many Wall Street professionals uneasy.

RIA portfolio manager Michael Lebowitz stated:

"Option buyers are generally more hedging buyers, but the skew currently tells us that there are more speculative traders now."

As a super heavyweight stock, NVIDIA has contributed approximately 25% of the S&P 500 index's gains this year. Independent stock market analyst Michael Kramer mentioned that NVIDIA's earnings report could be crucial for the market's success. Kramer said:

"I believe the market has placed a huge bet on NVIDIA. If NVIDIA's stock price does not rise significantly, there are no other factors to drive the U.S. stock market higher."

Data from derivatives market platform SpotGamma shows that as of last Thursday, the skew of NVIDIA call options reached the highest level since June. Skew represents the implied volatility levels of OTM call and put options, indicating that the implied volatility of NVIDIA's OTM call options is significantly higher than put options.

The surge in NVIDIA call options has forced market makers to frantically buy the underlying stock to establish Delta hedging positions, which has largely supported NVIDIA's stock price and further fueled the rally.

The act of "releasing earnings report" poses the greatest risk

SpotGamma founder Brent Kochuba believes that once NVIDIA releases its earnings report, the implied volatility of the entire options market may decrease, causing a drop in the prices of NVIDIA-related call options and triggering a market pullback.Kochuba explained that due to the current rise in implied volatility in the options market, based on investors' expectations to hedge or speculate on the "NVIDIA earnings report," the implied volatility will decrease after NVIDIA announces its earnings.

If the options move into the money, options market makers may be forced to deliver the underlying stocks used for hedging. Kochuba also stated in a client report:

"Companies with a significant skew towards bullish options may face greater selling pressure."

It is reported that tech companies like Microsoft, AMD, and Arm currently have extremely high skew towards bullish options.

US Stock Market Rally Outpaces Profit Growth

It is certain that the AI frenzy is the main driving force behind the stock market rally, but this does not mean that traders can easily profit by betting on AI.

On one hand, major US stock indices are hitting historical highs, while on the other hand, Wall Street analysts have lowered their expectations for corporate profit growth in 2024. The overall dynamic P/E ratio growth of the US stock market has slowed down, and the stock market rally has surpassed profit growth, raising concerns about the market being "overheated."

Kramer pointed out:

"The current stock trading relies not on earnings momentum, but on multiple expansion."

Bret Kenwell, a US options investment analyst at eToro, believes that NVIDIA finds it more challenging to achieve sustained profitability due to its high earnings threshold:

"The speed of this rally in the US stock market is actually unsustainable - for companies like NVIDIA, they have set a quite high threshold for profitability - but it is always the most difficult part to predict when the momentum will fade."