Beware the index bump?

Whenever you hear about a stock being added to a major index, you’ll often see a flurry of trading activity—often on the buy side.

This isn’t just a matter of a company benefiting from “good press,” although being admitted to the ranks of a widely followed stock barometer could certainly be considered positive (not to mention free) publicity. The more practical side of things is that when a company is added to an index, all the funds tracking the index need to buy that stock. 

That’s why some traders look to trade the potential boost that can occur when a stock gets added to an index. For example, Alcoa (AA) jumped 5.6% on Tuesday after news that it had been tapped for inclusion in the S&P 400 index (MID)—a rally that was all the more impressive given the selling that dominated the market that day:

Yesterday morning, though, AA shed as much as 4.8%, although it erased that loss later in the trading session.

Airbnb (ABNB) offers some additional insights about the supposed “indexing bump.” News the stock was being added to the Nasdaq 100 (NDX) on December 10 not only failed to push shares into the green for the day, the stock was down nearly 12% in four days at yesterday’s low, and down nearly 25% from its eight-month high of $212.58 from mid-November:

iSetting aside any longer-term outlook for either AA or ABNB, in both cases traders who bought on the day of the indexing news would have found themselves in the hole within 24 hours. With that in mind:

1. Other factors can outweigh any potentially positive effect from being added to an index. In the case of ABNB, for example, news of its addition to the NDX came as the stock—like many others in the travel and leisure space—was still arguably feeling the uncertainty of the Omicron variant.

2. Funds don’t have to repeatedly buy stocks that are added to the indexes they track, they just need to do it once. Translation: Even if an indexing bump occurs, it can come and go more quickly than traders assume (although not necessarily in a single day).

This is why some traders consider selling call options in the wake of a stock’s addition to an index: The implied volatility surge that can accompany the news may temporarily overinflate options premiums, which may then retreat unless the stock keeps pushing significantly higher, and (especially in the case of short-term options) because of time decay.

Of course, there are exceptions. On May 25, The Joint Corp. (JYNT) jumped 18% on news it was being added to the S&P 600 index—and then climbed an additional 62% over the next three months before turning significantly lower.

But that’s simply a useful reminder to never take anything for granted in the markets—and to account for all the potential catalysts that may drive a stock at a given time, not just a single factor like indexing.

Market Mover Update: For the record, Tuesday’s volume surge in Endeavor Group (EDR) options appears to have been traders mostly getting into the market, not out of it. Yesterday, open interest in the February $35 calls was 18,500—up 9,100 contracts from Tuesday (see “Options talent show”).

Today’s numbers include (all times ET): Housing Starts and Permits (8:30 a.m.), Weekly Jobless Claims (8:30 a.m.), Industrial Production (9:15 a.m.), PMI Composite Flash (9:45 a.m.).

Today’s earnings include: Accenture (ACN), Adobe (ADBE), FedEx (FDX), Jabil (JBL).

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