It’s practically a law of markets: when stock prices rise, stock volatility falls. But lately the relationship has been breaking down, and the sleuths are out trying to explain why.
(Bloomberg) — It’s practically a law of markets: when stock prices rise, stock volatility falls. But lately the relationship has been breaking down, and the sleuths are out trying to explain why.
A suspect emerging in the case, according to Citadel Securities, is day traders, who plowed into equity options in the middle of the month. That’s right around the time when the S&P 500 and the Cboe Volatility Index were staging unusually strong lockstep moves. So it appears the options-trading spree was big enough to move the volatility gauge or VIX, which uses such contracts to measure the expected price swings ahead for the S&P 500.
During the week through June 16, retail traders’ options volume on Citadel’s trading platform surged to the highest level since November 2021, with transactions in bullish calls outpacing bearish puts by a big margin. To Layla Royer, the firm’s senior equity derivatives salesperson, it’s not a coincidence that the S&P 500 jumped about 1% while the VIX climbed in two separate sessions of that week, bucking the historical pattern.
During the past decade, synchronized gains of that magnitude occurred only twice before in the same week: March 2020 and November 2017. And the pattern was briefly on display Friday morning, as the Nasdaq 100 again rallied along with its volatility gauge.
“Vol Up + Spot Up in equity markets is intensifying,” Royer wrote in a note to clients. “Retail’s increased options volumes/call activity could be a contributor.”
The analysis sheds light on a curious market pattern that has gained traction in recent years. Usually, traders turn to bearish put options for protection when stocks decline, contributing to the inverse relationship between the VIX and S&P 500. Last year, however, the two spent a quarter of the time moving together — a frequency not seen in 16 years.
Theories have been proffered to explain the behavior. One ties it to market psychology — fear of missing out among day traders who used bullish call options to chase gains. In the case of defensively positioned institutional investors, such contracts were also employed as a hedge.
With an eight-month stock advance defying naysayers and the S&P 500 blasting through the 20% bull-market threshold, investors wanted a quick way to catch up — and options are a preferred tool for doing so.
In another sign of the prevailing FOMO sentiment, stock-market swings have been more pronounced on the upside. When the market rises, it has risen by a lot, while the down days have been more subdued.
The S&P 500 has gone 25 straight sessions without a 1% drop, the longest such streak since November 2021. Yet over the same stretch, it has scored gains of that size four times.
Since January, the index has advanced a median 0.8% on positive sessions, compared with a decline of 0.5% on negative ones. Not since 1991 have stocks endured a wider performance gap between up and down days on a full-year basis, according to data compiled by Bloomberg.
“The market is acting more ‘surprised’ by large moves up than small moves down,” said Danny Kirsch, head of options at Piper Sandler & Co.
Indeed, the 2023 equity rally has caught many off guard, including Wall Street strategists who called for a first-half meltdown and money managers who had raised cash in anticipation of a recession. But such gloom has taken a backseat recently, thanks to better-than-expected economic data and corporate earnings.
Meanwhile, optimism over artificial intelligence has fueled a rebound in technology megacaps such as Nvidia Corp. and Microsoft Corp. that are seen at the center of the innovations.
That resurgence has lured day traders, with tech names making up 79% of retail’s top 20 options volume in the past month, data from Citadel Securities shows. In June, trading in calls has outstripped puts by a ratio of 2.2-to-1.
Notably, the Nasdaq 100 has demonstrated a similar tendency of rising or falling more frequently with the Cboe NDX Volatility Index, a VIX counterpart for the tech-heavy measure. The two have posted harmonized moves about 28% of the time this year. If that rate holds through December, it would be higher than any year in almost two decades, except for 2017.
Royer at Citadel Securities observed that the market’s “spot up, vol up” dynamic has gathered steam since 2020, a year when small-fry traders started flocking to stock trading as a Covid-lockdown pastime, emboldened by zero brokerage commissions and stimulus checks.
From 2013 to 2018, there were only seven instances in which the S&P 500 rose more than 0.75% and the VIX was also up. Since then, such occurrences have more than tripled to 25, all happening while retail’s options volumes at Citadel Securities doubled from pre-2020 levels.
To Royer, the current dynamic echoes the second half of 2020, when a cluster of synchronized stock and VIX rallies took hold. Back then, while the cash index ultimately surged 17% over a six-month period, it suffered three separate pullbacks, each exceeding 8%.
“The current similar combination of Spot Up/Vol Up + increased retail activity could point to additional volatility,” she said.
(Adds Friday moves for Nasdaq 100 and its volatility in fourth paragraph)
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