ADVERTISEMENT

Bulls Nursing Wounds After Rout Eye Options Market For Solace

Options Market Is Signaling Stocks Selloff Is Approaching an End

Stocks are selling off, dragging the S&P 500 down more than 5% from its all-time high set early last month, but the options market may be signaling that the rout is nearing an end.

To wit: Selling one S&P 500 put contract that’s 10% out of the money now buys fewer equivalent call options than it did three months ago. The observation by RBC Capital Markets is no guarantee that the worst of the rout is over. But it could be a sign that some options traders think so.  

Derivatives traders have been preparing for this downturn since early summer, piling into puts as the stock market ascended to new highs. So when the rout finally happened, yanking more than $2 trillion in market value from from the S&P 500, few were caught by surprise. Demand for protection may be elevated, but there are few signs of panic.

“The market was worried for a long time (very high skew levels) even after we had drawdowns,” Amy Wu Silverman, a derivatives specialist at RBC, wrote in an email. “It is very telling that this time around the skew is not rising despite a drawdown. I think it’s the options market way of telling us that we are closer to the bottom.”

Bulls Nursing Wounds After Rout Eye Options Market For Solace

One put contract expiring in November that’s 10% out of the money can be traded for 27 out-of-the-money calls, Silverman’s calculations show. That’s down from nearly 37 three months ago.

Rotation Fears

This is not the case for the entire stock market. While the buying power of put contracts has fallen in the S&P 500 and small caps, it’s moving in the opposite direction for tech companies. That’s in line with a rout in the NYFANG Index that’s down around 3% Monday and teetering near correction territory with a more than 9% decline from its September high.

The selloff, which was sparked a range of factors from commodity inflation to political static around the Federal Reserve to the government debt ceiling, has raised volatility across the board. But traders’ perception of risk hasn’t been symmetrical. 

The S&P 500’s skew, which measures the cost of bearish versus bullish bets, has risen the most in the 97 area and is now up about 11 volatility points from three months ago, data compiled by Bloomberg show. It’s up six vols in the 90 area. To Interactive Brokers’ Steve Sosnick, that means traders don’t appear too concerned about a 10% rout. 

Bulls Nursing Wounds After Rout Eye Options Market For Solace

“It’s telling us where the maximum nervousness is,” Sosnick said. “The focus of their concern appears to be within a 0% to 5% decline, versus a 10% to 20% correction.”

Of course, this doesn’t mean the stock-market drama is over, particularly without the signs of a cathartic surrender that often precede bottoms. The Cboe Volatility Index is trading near 24. To Nicholas Colas, co-founder of DataTrek Research, a reading of 36 typically signals what he calls a “tradable low.”

©2021 Bloomberg L.P.