“Index effect” helps small cap go big

04/07/21
  • CARA rallied 18% intraday on news of addition to S&P 600
  • Stock gained 19% in days leading up to announcement
  • Index effect: Stocks can jump as funds add them to their portfolios

There are always multiple factors driving stock moves—company-specific news, broad-market or sector trends, portfolio rebalancing. But Tuesday provided an example of a catalyst many traders and investors may not think about too often.

Among the stocks on yesterday’s LiveAction scan for high call volume was one Cara Therapeutics (CARA), a biopharma company with around 80 full-time employees, a $1.35 billion market cap, and Q4 net income of $8.4 million.1 By 11:30 a.m. ET, though, more than 13 times the average number of CARA call options had changed hands:

Chart 1: LiveAction scan: Unusual call volume. Unusual options activity. Call volume more than 13x avg.

Source: Power E*TRADE


The stock popped up on a couple of other scans for unusual activity, including the one for biggest percentage gains—thanks to an 18% intraday rally, which followed a 19% surge in the four days leading up to yesterday’s news:

Chart 2: Cara Therapeutics (CARA), 4/8/20–4/6/21. Cara Therapeutics (CARA) price chart. Welcome to Indexville.

Source: Power E*TRADE


What was all the apparent bullishness about—a new product launch, a successful clinical trial, a buyout or merger?

None of the above. However, Standard & Poor’s announced it was adding CARA to the S&P 600 Small Cap Index, effective today.2 In addition to simply being a nice PR coup for any company, being added to a high-profile index often has a more practical side effect: an immediate price bump, since funds tracking the index need to add the stock to their portfolios.

And when they’re done buying? Since it’s a one-time event, the “index effect” typically has a relatively brief shelf life, although other factors (including investor enthusiasm about the indexing) can make it difficult to decipher what’s really driving a move at a given time, especially in the case of stocks that were already in strong uptrends when their indexing announcements occurred.

That brings us to a couple of other interesting aspects of yesterday’s activity. Around the time CARA’s call volume was running around 13 times average, another scan showed put options volume was more than 20 times average. Also, CARA’s monthly chart shows yesterday’s rally pushed the stock very close to its 2017 all-time high of $28.50:

Chart 3: Cara Therapeutics (CARA), 1/31/14–4/6/21 (monthly). Cara Therapeutics (CARA) monthly price chart. CARA long-term price chart. Near long-term highs.

Source: Power E*TRADE


Two things options traders may be watching in light of yesterday’s developments:

1. By midday, CARA’s rally had triggered a 130%-plus jump in the May at-the-money (ATM) calls and a 65%-plus sell-off in the May ATM puts.

2. Implied volatility (IV) was well above average for April options, and below average for the May puts.

Whether or not CARA continues to make new highs, the index effect has a limited window—after all, funds only need to add a stock once. When that dust settles, traders often refocus on other factors.

Market Mover Update: Home Depot’s (HD) appearance on Tuesday’s LiveAction scan for high put-call ratios highlighted a conspicuous run: Tuesday marked the 22nd consecutive day that HD made either a higher close or higher high (yesterday it was the latter). Despite closing modestly lower, the stock is still up more than 25% since March 4.

Today’s numbers (all times ET): Mortgage applications (7 a.m.), International Trade in Goods and Services (8:30 a.m.), EIA Petroleum Status Report (10:30 a.m.), FOMC minutes (2 p.m.), Consumer Credit (3 p.m.).

Today’s earnings include: MSC Industrial (MSM), Simply Good Foods (SMPL), Lamb Weston (LW), RPM International (RPM), Schnitzer Steel (SCHN).

 

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1 MarketBeat.com. Cara Therapeutics Income Statement & Balance Sheet. 4/6/21.
2 CNBC.com. Stocks making the biggest moves in the premarket: Illumina, Cara Therapeutics, Snap & more. 4/6/21.

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