The Latest Rally Has Energized the Stock Market but Left the Credit Market Concerned

Options traders are chipper about equities but wary of debt

Wall Street has a different view about downside protection on stocks and bonds.

The latest stock market rally has energized equity bulls but left credit investors much more wary, according to Barclays.

The bank's global equity derivatives strategy team led by Stefano Pascale noted that option markets suggest "a divergence of downside opinions" for traders of stocks and bonds.

In commentary published Thursday, the Barclays team looked at what's known as skew for the State Street SPDR S&P 500 exchange traded fund SPY, the most popular ETF tracking the S&P 500 equity index, and the iShares iBoxx $ Investment Grade Corporate Bond ETF LQD, a widely tracked proxy of the investment-grade corporate debt market.

In option markets, call options give the buyer the right to purchase the underlying security - say, the SPY or LQD - at a particular price within a specified timeframe. A put option gives the buyer the right to sell the underlying security under the same criteria.

Skew refers to the price difference between upside and downside protection. Because markets tend to drop faster than they rise, put options (downside insurance) are usually much more expensive than call options (bets on a rally). Skew in this instance measures how much extra premium traders pay for puts relative to calls.

The Barclays team found that over the past week, during which the S&P 500 hit a fresh record high, "skews across global indices collapsed as investors chased the rally and demand for protection faded."

However, while stocks were rallying, investors were getting more wary about inflationary pressures, which were forcing bond yields higher.

There also has been increasing nervousness about the credit profiles of heavy-spending hyperscalers, where the cost of insuring their debt has been climbing in recent months.

Consequently, Barclays said: "In contrast, skew on credit ETFs, led by LQD, steepened sharply, opening a notable divergence in downside risk perceptions across asset classes."

Early on Thursday, futures pointed to the S&P 500 (ES00) eyeing a fresh record, while the iShares iBoxx $ Investment Grade Corporate Bond ETF was up about 0.8% in premarket action.

-Jamie Chisholm