Small-cap stocks face dual risks in their upward trend! BNP Paribas calls for positioning in Russell 2000 index put options to hedge risks

According to the Zhitong Finance APP, after the U.S. stock market set a record for the longest consecutive rise in 20 years, a strategist from BNP Paribas believes that now is a good time to guard against declines in small-cap stocks. Greg Boutle, head of U.S. equity and derivatives strategy at the bank, believes that the rapid rise in the stock market in late April seems to have shown signs of fatigue.

Boutle stated that the reversal of good fortune for small-cap stocks may be the most severe. He suggested that traders buy put options on the Russell 2000 index, which is primarily composed of small-cap stocks, and purchase options expiring in July to capture two potential events that could trigger volatility: the Federal Reserve's interest rate decision on Wednesday and the end of the suspension period for Trump's reciprocal tariffs.

In an interview, he said, "We believe that small and mid-cap stocks are essentially the parts of the market with weaker pricing power, higher leverage, and lower profit margins, so if the economic slowdown becomes more severe, they will be the first to suffer." He added that economic data released in June and July is more likely to reflect a slowdown in hiring and consumer spending related to tariffs.

Despite these risks, the downside hedging costs for small-cap stocks relative to the S&P 500 index are relatively low, making them an attractive hedging tool in the eyes of strategists like Boutle.

In fact, compared to the SPDR S&P 500 ETF Trust, an implied volatility indicator for the iShares Russell 2000 ETF is currently close to its lowest level since March 2020.

Although the market generally expects the Federal Reserve to keep interest rates unchanged, all eyes will be on Federal Reserve Chairman Powell's press conference, where he may provide clues on how to respond to tariff impacts.

Boutle stated, "If the Federal Reserve sends a hawkish signal that leads to a decline in the stock market, this hedging strategy will be effective." However, even if the Federal Open Market Committee meeting is relatively 'dull', there is still ample time for tariff-related pressures to impact U.S. small businesses.

Last month, due to concerns about economic growth slowing from Trump's tariffs, small-cap stocks fell 14% over four trading days, causing more damage to domestically-focused companies than to multinational corporations. Although small-cap stocks have since recovered most of their losses, persistent inflation and escalating geopolitical tensions pose significant threats to small businesses.

Of course, the stock market's upward momentum may continue, especially if Powell hints at a possible interest rate cut at the mid-June meeting.

Additionally, Boutle noted that trend-following hedge funds are expected to buy about $20 billion in stocks this week, having already purchased $10 billion to $15 billion in late April. This momentum buying could undermine hedging strategies based on pessimistic expectations for the U.S. economy. Boutle stated, "Tactically, this is an excellent balancing tool against overly stubborn bearish positions." However, other analysts also recommend buying put options on the Russell 2000 index. Jeff Jacobson, head of derivatives strategy at 22V Research, wrote in a report to clients on May 4: "I continue to view small-cap stocks as a new preferred hedging tool," noting the resurgence of large tech stocks. "When leading stocks are underperforming, small-cap stocks are still unable to outperform large-cap stocks; what chance do they have now?"