MW Stock-market crash fears are fading, according to options traders
By Joseph Adinolfi
Options traders show less interest in contracts that would pay off in a market meltdown
As U.S. stocks rebound from last month's selloff, options traders are showing less interest in contracts that would pay off if the market were to crash.
Demand for "out-of-the-money" puts relative to "at-the-money" puts on the S&P 500, a measure known as "put skew," has diminished after rising last month, according to data from Nomura's Charlie McElligott. The gauge is used by Nomura and others to gauge traders' demand for crash protection.
At the same time, demand for options tied to the Cboe Volatility Index VIX, which typically pay off when markets suddenly sink or rally, has also fallen. This has driven the Cboe VVIX , a gauge of demand for such bets, to its lowest level in a decade on Monday, according to FactSet data.
The VIX itself, which is based on activity in one-month S&P 500 options, has fallen to its lowest level since late March.
McElligott described the drop in the VVIX as "the clearest expression of the 'Disappearing Demand for (Downside) Tails'" in emailed commentary shared with MarketWatch on Tuesday.
A put option gives the holder the right, but not the obligation, to buy the underlying asset at a set price, known as the strike price, by a certain date. That means a put can be used to effectively insure, or hedge, a position against a market decline.
An option is said to be "at the money" if its strike price is roughly in line with where the underlying stock or index is currently trading. An "out of the money" put is a contract where the strike price is meaningfully below where the underlying is currently trading.
What is more, traders are once again scooping up out-of-the-money call options on the S&P 500, as the strategy of buying bullish options to try to chase the market higher comes back into vogue, he added. A call option gives the holder the right to buy at a set price by a certain date.
According to McElligott, declining demand for crash protection has been driven by two developments over the past week. The first was Federal Reserve Chair Jerome Powell's dovish tone at the postmeeting press conference on May 1.
As he took questions from reporters after the meeting, Powell characterized another rate hike from the Fed as "unlikely" and said the central bank stands ready to act should the U.S. economy, especially the labor market, suddenly weaken.
The Fed also reduced the cap on the amount of Treasurys it would allow to roll off its balance sheet every month by more than investors' had expected.
The second was a batch of economic data that suggest the U.S. economy may finally be starting to weaken under the weight of the highest Fed interest rates in more than 20 years.
Friday's nonfarm payrolls report for April helped cement investors' belief that the labor market has started to slow. For months, investors saw signs of cracks forming beneath the surface as large headline readings were consistently revised lower.
Now, after Friday's weaker-than-expected headline reading, traders are bracing for the possibility of a swift rise in the unemployment rate as slowing demand for labor collides with an influx of immigrant workers, McElligott said.
These developments have also contributed to the swift rebound in U.S. stocks, as interest-rate futures traders have put two Fed rate cuts back on the table for 2024, according to data from CME Group.
The S&P 500 SPX was struggling to climb for a fifth straight day on Wednesday, according to FactSet data, after having climbed more than 3% since the beginning of May.
The Dow Jones Industrial Average DJIA was up 117 points, or 0.3%, at 39,002, leaving it poised to climb for a sixth-straight day.
The Nasdaq Composite COMP remained down 27 points, or 0.2%, at 16,305 as shares of megacap stocks like Nvidia Corp. $(NVDA)$ and Tesla Inc. $(TSLA)$ weighed on the tech-heavy index.
-Joseph Adinolfi
This content was created by MarketWatch, which is operated by Dow Jones & Co. MarketWatch is published independently from Dow Jones Newswires and The Wall Street Journal.
(END) Dow Jones Newswires
May 08, 2024 14:55 ET (18:55 GMT)
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