Options Are Signaling a More Placid Stock Market Through Yearend

(Bloomberg) -- U.S. equity investors who have endured some of the widest price swings on record amid the worst pandemic in modern times could be in for a respite as 2020 comes to a close.

Current 30-day implied volatility on the S&P 500 is around 19, compared with 81 in the February-March period when stocks plunged as much as 35% as Covid-19 rocked financial markets. While that metric is high compared with recent history, having averaged 7 for all of 2019, the push and pull of options investors suggests stocks may trade within a tighter range through yearend.

The S&P 500 has risen almost 11% year-to-date. Most of those gains have come this month after the U.S. presidential election and positive results from coronavirus vaccine trials eased some of the uncertainty that had stalled the market’s rebound from its lows in March.

A number of recent large options trades are pointing toward limited gains for the broader equity markets as bullish bets have been closed out and larger index hedges have emerged. Those trades, combined with recent bullish and bearish bets into year-end on the Russell 2000, indicate that options investors believe markets are in for a period of relative calm.

Markets could be in a “sweet spot” for selling near-term volatility as overhangs including the U.S. election and questions about the efficacy of Covid-19 vaccines under development have been lifted, Chris Murphy, the co-head of derivatives strategy at Susquehanna wrote in a note this week.

Hedging continued Thursday as bearish put spreads in large exchange-traded fund tracking the S&P 500 and Russell 2000 were bought with Dec. 31 expiration. Those trades involved buying contracts with strike prices that are closer to the last sale, combined with selling contracts that are further out-of-the-money. It shows investors may be willing to add long exposure in the event of a market sell-off, creating additional demand for equities.

Last week, a number of bullish options bets on large-cap technology stocks that were initiated in August began being closed out, indicating that a large investor dubbed the “Nasdaq Whale” had re-emerged to close bets in Microsoft Corp., Apple Inc., Amazon.com Inc. and Salesforce.com Inc. That trend continued this week when bullish December call spreads were closed in Microsoft and Facebook.

While the largest macro events have passed, one investor recently initiated what strategists at Susquehanna called a “tail hedge” on the $318 billion SPDR S&P 500 ETF Trust through a sizable bearish December put spread. That trade could have as much as a 31-to-1 payout if the S&P 500 plunged about 18% over the next month, they said in an interview.

Meanwhile, both bullish and bearish options trades have emerged in the $48.5 billion iShares Russell 2000 ETF. Last week, a bearish put spread that is set to expire on Dec. 31 was initiated, also targeting about 18% downside. A few days later, a bullish Dec. 31 call spread was bought that targets a limited rally into yearend.

©2020 Bloomberg L.P.