With Stocks Nearing Peaks, Options Market Sees Return of Complacency

As stocks resume their upward climb towards record highs following a brief April downturn, a sense of complacency is returning to options markets. This shift is evident in the decreasing prices of hedges designed to protect investors’ portfolios against potential market pullbacks or crashes.

Rocky Fishman, founder of Asym 500, a firm specializing in options market data and analytics, notes a substantial decrease in the cost of these contracts since the beginning of May.

The rebound in stock prices has led to a significant narrowing of the spread between the Cboe Volatility Index (VIX) and actual stock volatility, reaching one of its lowest levels in years. The VIX, often referred to as the “fear gauge,” has fallen to its lowest level since January, signaling reduced expectations for market volatility.

This decline in volatility has made crash insurance, in the form of VIX calls, extremely affordable. For example, VIX call options with a strike price of 25 expiring in around 40 days are currently trading at just 30 cents per contract, a considerable decrease from their cost a year ago.

Furthermore, protection against even a modest market downturn has become cheaper, as indicated by the reversal of the S&P 500 index skew. This shift suggests that traders are once again preferring bullish calls over bearish puts.

The accessibility of VIX calls and index puts presents an opportunity for investors seeking to take positions, such as anticipating higher-than-expected consumer price index reports. However, any signs that the slowdown in inflation could be more enduring might prompt a reevaluation of the timing of Federal Reserve interest rate cuts.

Despite a brief setback in April, both the S&P 500 and the Dow Jones Industrial Average have largely recovered, with the S&P 500 securing its third consecutive weekly gain and the Dow Jones rising for an eighth straight session. However, the Nasdaq Composite experienced a slight decline amidst these movements.