Risk appetite is making its way back in the stock market, but among options traders, concern is high that the selling isn’t over yet.
One of the key signals for the options market -- demand for hedging against losses in individual companies -- shows that a seven-week rout did little to tame traders’ appetite for the hedges. In fact, the ratio of put to call contracts on individual stocks on the Cboe rose to the highest level since March 2020. While protection appetite subsided on the index level after a 19% S&P 500 slump, traders are still guarding against single-stock blowups.
There was hardly a lack of them lately. Walmart Inc. and Target Corp. clocked their worst day since 1987 amid disappointing earnings last week. Dollar Tree Inc. and Cisco Systems Inc. both posted a 14% down session, while Advance Auto Parts Inc. lost this much for the week.
Risk appetite was on display on Monday, with the S&P 500 rising 1.6% on 1 p.m. in New York, while the Nasdaq Composite Index was gaining 1.2%. In the options market, trading volume in contracts betting on rising volatility outnumbered those betting on calm by a factor of 2.2, while put options volume in the SPDR S&P 500 ETF Trust was 1.8 times higher than call volume.
To strategists at Jefferies LLC., the lack of uncertainty around the direction of the economy amid a hawkish Federal Reserve that’s fighting inflation are setting the stage for more pain before things turn around. They analyzed forward returns after the 500-member gauge dropped 10%, 15%, 20% and 25% from its previous highs. The analysis -- going back to the 1950s --- shows that unless the gauge clears the 25% selloff mark, it doesn’t come even close to recouping its losses within a year.
“There’s a better chance of the market being stuck in no man’s land than marking a bottom,” Jefferies strategists including Andrew Greenebaum wrote in a note. “While some might be feeling more constructive (particularly on long duration assets) after the recent rout, we actually believe that the current price action is more suggestive of danger ahead than smoke clearing.”
The view is echoed among participants in the latest MLIV Pulse survey. After losing 19% between early January and Friday, the S&P500 is likely to keep falling more this year -- before bottoming at around 3,500, according to the median projection of 1,009 respondents. That represents a decline of at least 10% from the Friday close of 3,901.
Strategists at BlackRock Investment Institute cut their view on developed stocks, including the US, to neutral Monday, citing concerns about growth and a hawkish Fed.
“The Federal Reserve signaled its focus is on taming inflation without flagging the big economic costs this will entail,” strategists including Jean Boivin said in a note to clients. “As long as this is the case and markets believe it, we don’t see the basis for a sustained rebound in risk assets.”
This article was provided by Bloomberg News.