Is the US stock market becoming more dangerous as it rises? A "calm storm" is quietly brewing, and exotic options have become the new favorite among investors

According to Zhitong Finance APP, as the S&P 500 index continues to hit new highs, a "calm storm" is brewing on Wall Street. Volatility indicators have fallen to multi-year lows, but savvy investors are positioning themselves with exotic options to hedge against a market pullback from these high levels. The S&P 500 index has been steadily rising, pushing most implied and actual volatility indicators to new lows for several months or even years. Given the geopolitical tensions and the uncertainty surrounding the impact of tariffs on corporate earnings, the significant drop in volatility after the tariff shock in April has surprised many investors. As a sense of complacency spreads through the market, coupled with the resurgence of meme stock frenzy indicating that investors are in a state of extreme excitement, Wall Street strategists are beginning to discuss measures to hedge against a market retreat from its highs. With the earnings season kicking off and the tariff deadline approaching, along with the Chicago Board Options Exchange Volatility Index (VIX) recovering from July's lows and entering a seasonal uptrend for the third quarter, hedging strategies may become more attractive. However, during rising market periods, simple strategies can become tricky, as small declines are viewed as buying opportunities. As the index rises, ordinary put options quickly lose value, forcing investors to constantly adjust their positions to maintain downside protection. As a result, strategists are starting to recommend alternative over-the-counter options. UBS and JP Morgan have recently suggested using so-called "backward-looking" or "resettable" put options, which have strike prices that dynamically adjust as the market rises. JP Morgan strategist Bram Kaplan's team stated earlier this month that the premiums for these options are currently at historical lows compared to ordinary put options. Antoine Porcheret, head of institutional structured business for Citigroup in the UK, Europe, Middle East, and Africa, stated, "Hedging strategies are receiving a lot of attention. We are seeing substantial buying flow for backward-looking put options, as their prices are low by historical standards, and their value depends on implied volatility, which is currently low." UBS strategist Kieran Diamond wrote in a report last week that historically, when the market is at high levels, it is often more likely to continue rising rather than falling, increasing the likelihood that ordinary put options will become out-of-the-money. Backward-looking options can provide more returns compared to ordinary options. The best time to buy backward-looking put options is after a market rebound followed by a crash. In this case, the additional returns compared to ordinary put options can be quite substantial. Pete Clarke, head of global volatility strategy at UBS, stated, "Earlier this year, when spot prices were near their highs and volatility was at lows, interest in backward-looking hedging strategies surged. Following the recent market rebound and volatility reset, we are seeing renewed interest from investors in these strategies." This week, the market will face another test, with the Federal Reserve's interest rate decision, U.S. employment and GDP data, tariff deadlines, and numerous large tech earnings reports coming in succession. At the same time, meme stocks have once again experienced significant volatility this month, which may lead institutional investors to seek protective trades rather than chase upward momentum. In 2021, a retail trading frenzy drove the stock market up, but that momentum quickly faded. Porcheret stated that interest in put options for backtesting "mainly comes from other institutions outside of hedge funds, such as asset management companies that only go long and private banks. Hedge funds, especially volatility arbitrage firms, tend to prefer lower-cost downside structured strategies rather than backtesting options that require additional costs." The volatility of tech stocks has significantly decreased, with ASYM 300 founder Rocky Fishman stating last week that the 10-day realized volatility of the Nasdaq 100 index has fallen to its lowest level since 2021. Porcheret noted, "The Nasdaq index and the entire tech sector have been quite favored by investors, as the volatility in these sectors has significantly decreased."