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Alarm Bells Ringing in Options Market Point to Volatility Ahead

Alarm Bells Ringing in Options Market Point to Volatility Ahead

(Bloomberg) -- Alarm bells are ringing in the U.S. equity-options market, and to Sundial Capital Research Inc. that points to one thing: a spike in volatility ahead.

Extreme readings in indicators such as the cost of S&P 500 Index hedges, short-volatility positioning and U.S. equity put-call ratios all suggest investor complacency is at exaggerated levels. The Cboe Volatility Index -- or VIX -- has fallen almost 40% from its October high as equities rallied to fresh peaks on a surge in optimism over a potential U.S.-China trade deal.

Alarm Bells Ringing in Options Market Point to Volatility Ahead

“A handful of indicators suggest a high probability of an ‘event’,” wrote Sundial founder Jason Goepfert in a note to clients Tuesday. “It doesn’t necessarily mean stocks will decline, but it does seem to be a good bet that at some point the VIX will jump.”

Here is a look at the options signals causing concern:

Term Structure

The difference in pricing of medium-term volatility futures relative to their short-term equivalents suggests investors are expecting more price swings ahead. The ratio of the four-month VIX contract to its two-month counterpart has risen to the highest since January 2018.

Alarm Bells Ringing in Options Market Point to Volatility Ahead

Option Skew

The renewed positive sentiment toward a trade deal has reduced demand for protection from a U.S. stocks sell-off. That has pushed down the premium investors pay for bearish put options over bullish calls. The S&P 500’s skew, a measure of that difference, has fallen well below average levels and is not far off its low for for the year.

Alarm Bells Ringing in Options Market Point to Volatility Ahead

VIX Positioning

Hedge funds betting that the risk-on market mood will continue have pushed wagers on a decline in equity volatility into uncharted territory. Net-short speculative positions in VIX futures surpassed 200,000 contracts for the first time on record, according to the latest Commodity Futures Trading Commission data through Nov. 5.

Alarm Bells Ringing in Options Market Point to Volatility Ahead

Put-Call Ratio

A Cboe gauge measuring the volume of bearish options bets relative to bullish ones for U.S. single stocks is also highlighting investor complacency. The indicator’s 10-day moving average hit the lowest level in more than a year last week. The gauge can often be a contrarian signal for equity markets.

Alarm Bells Ringing in Options Market Point to Volatility Ahead

The signals come as wealthy people around the globe are hunkering down for a potentially turbulent 2020, according to the latest survey from UBS Global Wealth Management. A majority of rich investors expect a significant drop in markets before the end of next year and almost four-fifths of respondents say volatility is likely to increase.

To contact the reporter on this story: Cormac Mullen in Tokyo at cmullen9@bloomberg.net

To contact the editors responsible for this story: Christopher Anstey at canstey@bloomberg.net, Cecile Vannucci, Teo Chian Wei

©2019 Bloomberg L.P.