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A closely watched measure of stock market sentiment has reached its highest levels since 2008, as options traders increasingly focus on making further gains in rising indexes rather than worrying about a potential sell-off.
The nearly 25 percent rise in Wall Street's benchmark S&P 500 index since the beginning of November has caught traders who expected higher interest rates to lead to a recession wrong.
Many are now picking up S&P index-linked options that pay dividends if the market continues to rise. Meanwhile, the strength of the rally, which came despite higher-than-expected inflation in January and February, means investors have largely chosen not to buy options that protect them from market declines.
Options are a type of derivative that give the right but not the obligation to buy an underlying asset at a certain price – a call – or sell an asset at a pre-agreed price – a put.
Puts are usually cheaper than puts, reflecting investors' typical preference to buy stocks and then cover their portfolio with puts.
However, this protection against index declines of less than 10 percent has become so cheap against the backdrop of the rapid rise in the US market that the so-called two-month skew – a measure of the difference between the implied volatility of puts compared to calls – for both the S&P & Poor's and the tech-heavy Nasdaq Composite fell to 16-year lows, according to Bloomberg data compiled by UBS. Implied volatility reflects the market's expectations of movements in a security's price over a specific period of time.
“There was a lot of fear of missing out, partly because it was a very strong rally, so the hedging for a lot of people is to make sure they have that upside covered,” said Gerry Fowler, equity and derivatives strategist at the Bank. UPS.
“No one is really worried about mini-recessions, so no one is interested in buying stocks,” he added.
Such a narrow price gap between buy and sell — a “flat skew” in industry jargon — is unusual during violent market rallies, when investors generally get insurance against potential pullbacks.
“Normally when you have markets at all-time highs, people start to get a little nervous and bid more long than they are long,” said Rocky Fishman, a derivatives analyst at research group Asym 500. “But that's not always the case — it's normal.” This certainly was not the case with regard to the dot-com bubble.
Another said that pricing in the options market this year confirms investors' confidence that the US economy is heading toward a so-called soft landing and not a recession.
A flat skew at the top of a market rally “could signal tension about valuations, making investors feel uneasy. Or it could be a chase to the upside, which is a sign that investors believe there is more to come,” Fishman added.
Investors are so bullish that “fear of a crash” now outweighs “any real concern about a correction downward,” said Charlie McElligott, managing director of multi-asset strategy at Nomura Bank, writing in a note to clients this week. “Foams at the mouth.”
Speculative assets have become increasingly popular as investors' appetite for risk returns.
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But despite their confidence in the continued rise, investors have not completely given up on insuring themselves against a collapse.
“People are 5 to 10 percent okay [market] He refuses. “What they're hedging is much larger moves, and they're doing that using out-of-the-money VIX options,” Fowler said, referring to derivatives that would pay out if Wall Street's “fear gauge” jumped. After an economic or geopolitical black swan event.
