(Bloomberg) — The dominance of a few technology giants in the benchmark S&P 500 Index is now carrying over into the niche market for dividend futures and options.
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The biggest impact from Nvidia Corp.’s earnings earlier this month wasn’t in US stocks: It was in a small but rapidly growing market for wagers on overall dividend payouts across the S&P 500. While most traders focused on earnings per share and capital spending plans, institutional investors active in the dividend space keyed in on Nvidia’s surprise 25 cent-per-share dividend, up from just a penny.
“In one fell swoop, Nvidia moved from being the 180th largest dividend payer in the S&P 500 to the second,” said Bram Kaplan, head of Americas equity derivatives strategy at JPMorgan Chase & Co.
The size of the dividend increase in a company that makes up 8.5% of the benchmark stock index caused a huge shift higher in the entire S&P Annual Dividend Index futures curve, delivering paper profits for traders owning call options, some of which jumped by almost 300% from before the declaration. It underscores the potential for further big shifts as indexes look to quickly add massive companies expected to go public in coming months, which may result in further rebalancing down the road.
“We’re seeing a relatively small number of mega-cap companies driving an outsized share of index earnings growth while often paying comparatively lower dividends than traditional sectors,” said Arnim Holzer, global macro strategist at Easterly EAB. “Markets appear to be pricing the belief that the AI and infrastructure capex cycle may be durable enough to sustain nominal growth and corporate cash flows despite elevated rates, geopolitical pressures and stubborn inflation.”
While investors in the US have long been able to structure such bets bilaterally with investment banks in over-the-counter transactions, listed derivatives are growing. The total open interest in dividend options jumped more than 80% from a year ago to a record 523,332 contracts as of Thursday.
“Amid shifting interest rates and economic uncertainty, managing dividend exposure has become a strategic necessity for investors,” said Tim McCourt, global head of equity, FX and alternative products at CME Group Inc. “People have finally figured out that in certain asset classes, it’s inefficient to trade OTC swaps and that they should trade listed products.”
Hedge funds dominate the action, though they are increasingly turning to agency brokers to matchmake dividend positions between each other.
“The options-on-dividends market has become increasingly broker-driven, as hedge funds seek access to a wider pool of counterparties and deeper liquidity,” said Nabil Hussain, managing director at London-based brokerage Vantage Capital Markets. “With bank desks becoming more selective in warehousing dividend risk, the market has evolved toward a model in which hedge funds are increasingly transacting with one another.”
In Europe, the focus has shifted to the upcoming index rebalance, with strategists seeing the upcoming changes as generally dilutive for Euro Stoxx 50 Index dividends. JPMorgan strategists recently noted that this year the number of potential entrants and exits is unusually high, which has prompted early discussion around the impact.
Banks now offer structured quantitative investment strategies (QIS) around European dividend futures, taking positions in response to pre-determined signals, according to Alexandre Alekhine, head of equity volatility QIS at BNP Paribas SA in Paris.
Index rebalancing is a pressure point for US dividends as well, with the small-cap Russell 2000 Index shuffling the deck on June 26. The most successful companies in the gauge by value appreciation, representing around 17% of market capitalization, will be promoted out of the Russell 2000 into the Russell 1000.
“The names migrating are mostly non-dividend players,” noted Kaplan. Those include buzzy AI and space sector stocks. Their weight will be mostly reallocated to remaining index members that tend to pay higher dividends, which could result in a 16.5% increase in annual Russell 2000 payouts when measured in index points, based on JPMorgan estimates.
Still, there are reasons to be cautious about the outlook for dividends, especially in the US.
Upcoming initial public offerings, notably the listing of SpaceX, will change the composition of the S&P 500 and the Nasdaq 100 Index. Adding a huge company that’s unlikely to pay significant dividends any time soon could push down average payouts.
That clash between higher-than-expected dividends by flush chip manufacturers and index implications of IPOs will be a point of tension in the market.
“With the potential for other companies to follow suit on dividend payments, and possible future company IPOs that could contrastingly dilute the dividend, it remains an exciting period for participants,” said Vantage’s Hussain.
–With assistance from Yiqin Shen.
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