MW Retail investors bought the dip DeepSeek dip. Here are the next trades for bulls or bears

By Jamie Chisholm

The latest AI-induced stock market wobble - when the Nasdaq Composite COMP lost 3.1% and Nvidia shed 17% in a day - poses a crucial question for investors.

Was the move overdone and therefore a buy-the-dip opportunity? Or does the news of DeepSeek's low-cost software lead to a longer re-evaluation of the U.S. AI trade and the unwind of crowded positioning?

A team of analysts at JPMorgan, led by head of Americas equity derivative strategy Bram Kaplan, have provided trading suggestions for either view.

The first thing to note is that judging by the action of retail investors on Monday, the buy-the-dip mentality was dominant.

According to JPMorgan, small investors on the day purchased $1.3 billion more stocks than their daily average of the last 12 months. Large-cap tech and broad based multi-cap exchange traded funds saw higher-than-average demand, with SPY, VOO, QQQ and SOXL exchange-traded funds collectively accounting for $700 million, said the bank.

Still, the buying was nuanced. Retail investors net bought Alphabet $(GOOG)$ and Nvidia $(NVDA)$ but not the rest of the Magnificent 7.

Presumably, these investors saw the risk-off move as overdone, and JPMorgan suggests their are other ways to capitalize on that view.

The bank screened for U.S. stocks whose options market is sufficiently liquid and with pricing that offered potentially high leverage to the stock's rebound. They suggest buying a call spread on these names with a February expiry. See the table below. A call spread refers to buying a call option (the right to buy) on a strike price, and paying for that by selling another call on a higher strike price of the same expiry. The trade works if the price of the underlying security rises.

Another trade is to take advantage of flattened volatility skew in the RTY, which tracks the Russell 2000 index. In simple terms, this mean that the option market is pricing a relatively equal chance of the RTY rising or falling. JPMorgan observes that on Monday the Nasdaq 100 and S&P 500 skew surged while the RTY's was little changed.

"We view this as an attractive way to fund a rebound trade, as RTY has a lower beta to the AI thesis than SPX (Tech and Comm. Services make up around 41% of SPX but only around 15% of RTY), and thus can be expected to rally on the upside if investors pour back into AIstocks," says JPMorgan. Beta measures a security's sensitivity to the broader market.

The bank suggests selling a 1 month RTY 105% call option (the right to buy the RTY at a price 5% higher than it is at the time) in order purchase around 4.5 1-month SPX 105% calls.

However, for investors who are concerned that Monday's sell-off may presage further declines, and thus want to have some protection, JPMorgan recommends short-dated SPX and NDX put spreads "to monetize the elevated skew."

A put spread is buying a put on a strike and selling another put on a lower strike of the same expiry. JPMorgan suggests buying a 1-month 97.5%-90% (between 2.5% or 10% below market price) SPX put spread, and using the same criteria for the NDX.

Another trade if the AI-sell-off continues is to use options to exploit the likelihood of bigger declines for tech group Vertiv Holdings $(VRT)$ relative to the "defensive and less volatile" power group Eaton $(ETN)$.

This can be achieved by selling around 2.4 of the 3-month 95% ETN puts to pay for a 3-month 95% VRT put.

-Jamie Chisholm

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January 28, 2025 07:06 ET (12:06 GMT)

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