Key Points

• Heavy buying of call options, including 0DTE derivatives, is fueling a stock rally, drawing comparisons to the dot-com bubble.

• First-quarter S&P 500 earnings grew 27.7%, the fastest rate since late 2021, inspiring increased forecasts for 2026 and beyond.

• The Squeeze Metrics Gamma Index reached its highest level since 2021, indicating extreme options-market positioning.

The options market may be fueling a runaway rally in stocks that has drawn comparisons to the peak of the dot-com bubble.

In theory, trading in stocks and futures markets should be driving activity in the options market. But lately, things have been working the other way around - helping to fuel what has been, by some measures, a historic stock-market comeback after a difficult first quarter.

Surging energy prices and worries about accelerating inflation and a potential Federal Reserve interest-rate hike helped drive the S&P 500 SPX to the brink of correction territory in March. Yet over the past seven weeks, stocks have rebounded higher. Despite Friday's tumult, the S&P 500 still cemented a seventh straight week in the green, after logging its biggest daily drop since late March, FactSet data showed.

Bullish investors have credited a blockbuster first-quarter earnings season with inspiring the comeback. As of Friday, the blended earnings growth rate for the first-quarter earnings season was 27.7% for members of the S&P 500. That would be the fastest rate of growth since the fourth quarter of 2021, when COVID-era stimulus was still coursing through the economy, according to FactSet's John Butters.

This has inspired Wall Street analysts to dramatically increase their earnings forecasts for 2026 and beyond, although the improving outlook has largely been driven by a handful of companies, primarily semiconductor and energy names.

Yet the growing popularity of options trading, including among individual investors trading on Robinhood (HOOD) and another brokerage apps, and a proliferation of products that use derivatives or offer leveraged returns has been helping change the market's structure, according to a handful of Wall Street experts.

As investors scrambled to get ahead of an aggressive rally, heavy buying of call options - including short-dated, zero-day-until-expiration (0DTE) financial derivatives - helped generate an aggressive "gamma squeeze." Some say it may have contributed as much to the move higher in stocks as the improving earnings outlook.

This past week, the Squeeze Metrics Gamma Index, which measures the dollar value of option dealers' exposure to the call options they have sold to clients, hit its highest level since 2021.

"We're really at a high historical level," said Fabio Ruggeri, founder and CEO of MenthorQ, which offers data and analytics on the options market geared toward individual traders.

When gamma is this high, options dealers are consistently forced to buy shares, or index futures, to remain "delta neutral." Typically, market makers don't want to be exposed to any directional risk tied to the contracts they bought and sold, so they hedge their books in a way to collect spread - the difference between a given contract's bid and ask price.

MenthorQ has its own gamma index, and it has been reflecting some of the most stretched positioning seen over the past year. The worry is that gains predicated on short-term options trades could quickly evaporate.

There have been notable instances where a "gamma squeeze" was blamed in part for big moves in individual stocks; the meme-stock rally in shares of Opendoor Technologies (OPEN) last summer was a notable example. But seeing the entire market swept up in something like this is pretty unusual, according to Daniel Roos, founder of VolSignals and a former options market maker.

"This is abnormal - I haven't seen anything like this in my entire career," Roos told MarketWatch.

Spot up, vol up

For most individual investors, monitoring fundamentals - like a company's earnings or valuation metrics, such as its price-to-earnings ratio - is relatively easy. The data is widely available for free online.

Tracking what is going on in the options market requires additional resources, including access to special data feeds. That can make it more difficult for the average investor to monitor what is going on.

Wall Street closely watches the options space, and there are models that monitor how market makers are positioned, based on transaction data from major exchange operators like Cboe Global Markets (CBOE).

Those tools now have Wall Street seeing evidence that positioning in options markets have grown extreme. For example, the correlation between the Nasdaq-100 index's NDX price and its implied volatility has flipped into positive territory for only the fourth time in the past decade. That's from a recent trading-desk note from a team of derivatives-market strategists at Goldman Sachs.

"Equity markets have crashed higher over the last month ... this has caused the correlation between spot index and implied [volatility] to firm," the Goldman Sachs team wrote in written commentary. This could suggest that extreme options volume has been a factor helping to drive recent gains for the Nasdaq-100.

Fortunately, for anybody who bought ahead of Friday's pullback, there is reason to believe stocks could trundle higher in the short term. According to the Goldman team, when extreme options positioning has emerged in the past, stronger-than-average returns have typically followed over the next month.

Roos, the former options market maker, believes the latest leg higher for stocks could ultimately give way to a painful pullback as investors take profits and positioning shifts.

Leveraged ETFs, which typically seek to amplify daily swings in a given stock or index, as well as funds that use options to generate income and hedge against losses, are also helping reinforce the rally, said Charlie McElligott, a cross-asset strategist at Nomura, in recent commentary. Leverage can magnify gains - but also amplify losses on the way down.

Correlation

The stock market's rally from the March selloff has been explosive - not to mention far more concentrated than what investors were seeing earlier this year.

As traders increasingly gravitated toward options tied to individual stocks - including hot semiconductor names like Micron Technology $(MU)$ and Broadcom $(AVGO)$ - another gauge that could indicate overcrowding has started to flash.

The Cboe Implied Three-Month Correlation Index hit close of 11.36 on Thursday, the lowest close since Jan. 30, 2025, according to Dow Jones Market Data. A couple of weeks after this earlier peak, the S&P 500 reached its peak. A decline that sent the index to the brink of bear-market territory began a couple of weeks later.

To Arnim Holzer, global macro strategist at Easterly EAB, that's just one more indication of how investors are crowding into options tied to hot tech names - focusing on the strong earnings picture while potentially ignoring macro risks.

"Mechanically, implied correlation tends to fall when investors expect stocks to move more independently, rather than purely as a single macro trade," Holzer told MarketWatch.

The big question is whether there's a risk of it suddenly imploding.

Macro risks came back into the picture on Friday as the Nasdaq Composite COMP finished 1.5% lower, erasing its gains from earlier in the week. That meant only the S&P 500 extended its win streak to seven weeks, Dow Jones Market Data showed. Investors blamed rising bond yields and disappointment with the outcome of President Trump's visit to China for the weakness in the stock market.

While one day does not make a trend, it could be an indication that investors are starting to shift their focus to broader risks like accelerating inflation, rising bond yields and the possibility of a Federal Reserve rate hike. If this continues, it could mean more pain for stocks ahead.