The options market is casting a wary eye on major stock indexes, and a hopeful outlook on top technology stocks, ahead of an extraordinarily heavy event-driven trading week.
The implied volatility of bearish puts on the State Street SPDR S&P 500, Invesco QQQ Trust, and iShares Russell 2000 exchange-traded funds are all slightly higher than for bullish calls, indicating investors are hedging the unusual confluence of events.
When investors think a company, or index, is more like to advance, they tend to buy calls, and that helps to increase implied volatility. When a company, or index, is expected to decline, put volatility increases. Volatility constantly changes, but comparing put and call volatility helps investors gauge outcomes.
On Wednesday, at 10 a.m., a Senate Banking Committee is expected to vote on Kevin Warsh's nomination to lead the Federal Reserve. At 2 p.m., the Fed's interest-rate setting committee concludes and will announce if interest rates will be lowered, or not.
To add more tension to that meeting, the Supreme Court earlier in the day might issue its decision on President Donald Trump's authority to remove Federal Reserve governor Lisa Cook from the independent agency.
If Trump prevails, presidential power will expand to monetary policy which has historically been beyond the White House's direct control. The ruling would be historic, and presumably enable a president to fire central bankers, possibly including current Chairman Jerome Powell.
To complicate matters even further, the threat of a kinetic war with Iran still looms over the market. Plus, four of the so-called Magnificent Seven stocks are scheduled to report earnings on Wednesday, and a fifth reports on Thursday.
These technology companies dominate the major indexes so their financial results, and especially their earnings outlooks, could create extraordinary price fluctuations at the equity and index level.
Options investors are pricing Wednesday's reports from Amazon.com, Meta Platforms, and Microsoft, and Thursday's report from Apple, in expectation the stocks will rally. Options on Alphabet, however, have a slight bearish tilt, reflecting recent concerns about the company's ability to compete in artificial intelligence against upstarts like Anthropic and ChatGPT. Alphabet's bearish put options, which increase in value should the stock decline, have slightly elevated implied volatility compared with the bullish calls.
The volatility conditions in the options market create both opportunity and risk for aggressive investors.
While we have counseled that speculating on earnings reports is gambling, it remains one of the most prevalent pastimes in the stock and options market. Many investors love trying to harness big stock moves, though few investors realize that implied volatility levels are always elevated ahead of events.
To potentially profit from the situation -- and this applies for indexes and equities -- two strategies are worth considering.
The risk reversal -- that is, selling a put and buying a call with a higher strike price but the same expiration -- pays investors for agreeing to buy stocks lower, while positioning them to profit from an advance.
Consider Meta. If you think the stock will rally on earnings, and you are willing to buy it lower, you could sell the May $670 put that expires Friday for about $21 and buy the May $685 call with the same expiration for about $22.60. The net cost was $1.60 when the stock was around $677.20.
If Meta is at $700 at expiration, the call is worth $15. Should the stock be below $670 at expiration, investors are obligated to buy the stock or to adjust the position to avoid assignment.
During the past 52 weeks, Meta has ranged from $520.26 to $796.25.
Investors who are concerned about a decline, for either stocks or indexes, can consider a put spread. The strategy entails buying a put and selling another with a lower strike price but the same expiration.
Consider the SPDR S&P 500 ETF.
With SPY around $714.91, investors could hedge the market by buying the May $706 put that expires on May 1, and sell the May $690 put with the same expiration. The spread costs $1.72.
If the ETF is at $690 or lower at expiration, the spread's maximum profit is $14.28. Should SPY rally, however, the money spent on the hedge would be lost. During the past 52 weeks, SPY has ranged from $541.52 to $714.47.
These strategies are designed to offer aggressive investors a way to express views on potentially volatile market-moving events without paying an extraordinary fear or greed premium in the options market. Anyone who bets right on the directional outcome before these events conclude will have monetized one of the most event-heavy calendars in recent memory.
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