Starting from Tuesday's opening bell, the market's direction clearly signaled an unusual rally was about to unfold. At the Chicago Board Options Exchange (Cboe), trading floor sentiment erupted instantly at the open, with heightened enthusiasm persisting through the close. The S&P 500 notched a fourth consecutive gain, with the total advance over this period approaching 6%; this benchmark U.S. large-cap index successfully broke through a two-month trading range. Bearish investors who had been betting on an imminent correction have seen their expectations completely shattered by this move.
Falling Treasury yields, lower international crude oil prices, and a broad rebound in previously battered tech stocks drove the action. Massive capital flooded into the Nasdaq 100 index: short covering and aggressive buying of bullish call options pushed a sentiment gauge to an extreme level rarely seen in nearly a decade. Data from index options analytics firm Nations Indexes shows that the price of out-of-the-money call options on the QQQ fund tracking the Nasdaq 100, with a one-standard deviation implied probability of 16%, surged 42% in a single day on Tuesday. This represents the largest single-day volatility jump for this type of contract in five years and the ninth largest in the past decade.
Scott Nations, President of Nations Indexes, commented: "Pessimistic investors are capitulating, and market optimism is fully erupting. Without exaggeration, this day ranks among the ten strongest bullish days for the Nasdaq 100 in the last ten years." The Invesco QQQ Trust, which tracks the Nasdaq 100, surged 3.3% on Tuesday, corresponding to a Nasdaq level of 29,733 points. Just last Wednesday, the index had plunged over 10% intraday; it is now within 3% of its June 3rd all-time high.
Exchange data reveals that Nasdaq 100 options volume this month has been 18% higher than the July average. Kevin Davitt, Senior Options Analyst at Nasdaq, noted in an email that after strong earnings reports and market stabilization following the Federal Reserve's rate decision, the market has regained its upward momentum, with funds actively participating in Nasdaq trading. The price of similar out-of-the-money call options on the SPY fund, which tracks the S&P 500, recorded its seventh largest gain in three years.
The buying spree for U.S. equity call options was unusually intense, creating a rare scenario: the stock market rallied while the VIX volatility index also rose. According to Convex Asset Management, this combination of market moves occurs only about 20% of the time. Noel Smith, Chief Investment Officer at Convex, cautioned in a conference call: "If you are looking to go long now, we do not recommend chasing these out-of-the-money call options. It's no longer the right time to position for this. If the broader market edges up but the VIX falls, the option returns will be very limited. If the spot price weakens alongside a decline in the VIX, this position could suffer significant losses."
The market's stabilization last week was triggered by news that legendary hedge fund manager Leopold Aschenbrenner's fund, Situational Awareness, was forced to liquidate billions of dollars in popular AI concept stocks. Concurrently, the decline in U.S. Treasuries halted as the 10-year yield failed to surpass last year's highs. On Tuesday, international crude oil prices fell below $80 a barrel, following comments from Donald Trump suggesting a deal with Iran was imminent.
More critically, long-time bears who had claimed the stock market was in a bubble were forced to confront two realities: corporate earnings are growing significantly, and overall stock valuations haven't become severely overinflated. According to FactSet, second-quarter earnings for S&P 500 companies are projected to grow 47% year-over-year, the fastest growth rate since the COVID-19 recovery period in 2021. The index's forward 12-month price-to-earnings ratio stands at 19.6 times, below its five-year average.
Tuesday's surge was not solely reliant on the rebound of tech mainstays like memory chip stocks. The materials and industrial sectors also rose 2%, providing support. The equal-weight S&P 500 ETF (RSP) gained 1.4%, bringing its year-to-date return to 14%, slightly outperforming the 13% year-to-date return of the traditional market-cap-weighted S&P 500 index.
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