By Bernard Goyder

(Bloomberg) -- Traders are placing bullish bets on small-cap stocks even though they have struggled to outperform their larger cohort over the past year.

The increased prospect of Federal Reserve interest-rate cuts is driving investors to look more positively at the smaller-listed companies that benefit from lower rates. And a drop in the relative cost of upside options on the Russell 2000 Index is making the wager more attractive, strategists say.

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“After getting hit in response to more hawkish rate cut expectations, the small caps have been a primary beneficiary of the more recent dovish tilt,” Christopher Jacobson, Susquehanna International Group’s co-head of derivatives strategy, wrote in a note to clients.

The Russell 2000 has jumped 8.5% in the five trading days through Friday, contributing more than 70% to its advance this year. The total amount of outstanding call contracts on the iShares Russell 2000 ETF, the largest exchange-traded fund tracking the index, jumped to the highest level since September when compared with open interest in put options, signaling optimism that the rally is set to continue.

The Russell 2000 includes companies that rely on shorter term borrowing to fund their activities, making them exposed to changes in short-term interest rates. Fed policymakers have indicated that a December rate cut still remains likely, while the potential appointment of a more dovish Fed chair next year bodes well for the sector. Futures traders are now pricing an 87% change of a rate cut in December, having given that outcome a 30% probability on Nov. 19, according to data from CME Group.

Jonathan Krinsky, BTIG managing director and chief market technician, said in a note that he thinks the small caps’ latest breakout “is more likely to stick.”

And bulls have history on their side. The index advanced at least 1.5% in each of the three sessions through Tuesday. In the 19 other times when that happened, the small-cap gauge stayed flat in the next month but posted above-average gains in the next three, six months and a year, data compiled by Bespoke Investment Group show.

With one month to go this year, the Russell 2000 is up 12% in 2025, compared with a 16% gain in the S&P 500. The small-cap gauge is on track to trail its larger peer for the fifth consecutive year, which would tie with late ‘90s for for the longest streak of underperformance ever.

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For now, subsiding demand for protection against a further drop in the Russell 2000 has kept the so-called call skew — a measure of the relative cost of more bullish options — subdued, giving investors an opportunity to bet on small-cap upside.

On Tuesday, one trader paid around $1.4 million in premium to buy bullish options that will profit if the iShares Russell 2000 ETF rises above $255 by Dec. 12, according to data compiled by Bloomberg. The ETF closed 2.5% away from that level on Friday. Separately, another trader bet that the fund’s share price will be 8% higher by February, according to Jacobson.

“Bullish positioning continues to build across expirations, from December short-term calls to longer-dated structures,” said Chris Murphy, Susquehanna’s co-head of derivatives strategy.

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