Investors are loading up on protection, while continuing to pile into bullish call options - a sign that many are bracing for an abrupt pullback.
The options market is sending investors a warning ahead of Nvidia's earnings: Things are about to get bumpy.
The Nasdaq Composite Index COMP tallied its first two-day pullback since March on Monday, capping off an epic comeback rally. High-flying semiconductor stocks have taken a hit, while beaten-down software stocks were enjoying a moment in the sun.
Brent Kochuba, founder of SpotGamma, believes a deeper pullback could be in the cards as investors await Nvidia's earnings after the bell on Wednesday - an event that's been known to move markets.
Furthermore, Kochuba thinks Nvidia's (NVDA) earnings could be a turning point for a jittery market if investors piled into bullish Nvidia call options take profits at scale, according to his latest commentary shared with subscribers and MarketWatch.
Kochuba and others have noted the Cboe Volatility Index VIX, better known as the "VIX," or Wall Street's "fear gauge," has been trending higher over the past couple of weeks - even as the S&P 500 SPX has charged to fresh record highs. That isn't always the case.
The relationship could be evidence that investors are bracing for a pullback, Kochuba told MarketWatch. The dynamic also has been showing up outside of the S&P 500: The below three major ETFs and a number of high-flying stocks have exhibited the same pattern.
The table above shows at-the-money implied volatility - typically represented as a positive number - as well as the implied volatility rank. This latter figure helps put the first one in context, showing exactly how large it is relative to a given lookback period.
Typically, implied volatility and spot price are inversely correlated for a given instrument, according to Kochuba. "When both rise together, traders may be paying up for protection even as they chase upside - a sign the market is bracing for expanded volatility," he wrote.
There may be reason to be nervious about Nvidia's earnings beyond the options-market activity. It is one of the final numbers from what has been a blockbuster earnings season. Many on Wall Street, including analysts at Bespoke Investment Group, have said that Walmart's earnings on Thursday will mark the unofficial end of what is shaping up to be a strong run of quarterly results.
After that, investors might struggle to find more good news to capitalize on - particularly if the situation in the Strait of Hormuz remains unresolved, and global bond yields continue to trend higher. In other words, Wednesday's Nvidia earnings report could be another "sell the news"-driven selloff, similar to what investors witnessed last time around, according to Art Hogan, chief market strategist at B. Riley Wealth.
"During earnings season, investors tend to shift their focus from the macro to the micro, with the micro being company by company reports. And ignoring a lot of the macro inputs that had been driving markets before the earnings season started," Hogan told MarketWatch during a Monday interview.
"Investors have been whistling by the inflation graveyard and ignoring signals from the Treasury curve, as we've broken above 4.5% and on a trajectory to go even higher," he added.
Rising bond yields look poised to provoke more of the volatility that investors saw on Friday and Monday.
"This is exactly what happened on Friday, the harsh reality of the real world where inflation remains stubbornly hot is starting to sink in," Hogan added.
The S&P 500 and Nasdaq composite both fell for a second consecutive day on Monday, according to FactSet data. For the Nasdaq, it was the first two-day pullback since March.
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