Hedging demand hits a 15-month high, is the rebound of US stocks coming to an end?
Traders are increasingly worried about whether the rally in U.S. stocks can continue, and are sparing no expense to hedge against risks in technology stocks. Despite NVIDIA's impressive performance, the volatility of the S&P 500 has increased, with the VIX fear index rising to its highest level since April. At the same time, Bitcoin has plummeted and its correlation with the Nasdaq has strengthened, leading to an increase in its bearish skew, which has intensified market tension. Some traders have already profited from the high volatility
Traders' concerns about whether this year's stock market rally can continue are intensifying. Although the S&P 500 index has risen more than 12% this year, investors are willing to spend to lock in profits, especially in the tech sector. The cost of options for Invesco QQQ Trust ETF has risen to its highest level since August 2024 relative to the SPDR S&P 500 ETF Trust, indicating a significant increase in market hedging sentiment.
The S&P 500 index has just recorded its largest weekly volatility range since June. Nvidia's impressive performance and Jensen Huang's assurance that artificial intelligence is not a bubble have failed to calm investors' unease. Meanwhile, Bitcoin has fallen about one-third since hitting a record high last month, and concerns about the Federal Reserve's interest rate cuts are also escalating.
Last Thursday, tech stocks experienced particularly severe volatility. The early gains following Nvidia's earnings report quickly reversed, leading to the most intense peaks and troughs in the market since April 8. The VIX fear index closed at its highest level since April, highlighting market tension.
The soaring hedging costs for tech stocks reflect investors' concerns about an AI bubble and a weakening bullish sentiment among retail investors, triggering sell-offs, with the sustainability of capital expenditures becoming a focal issue.
Volatility Premium Remains High
The risk premium between implied volatility and actual volatility remains relatively high. Rocky Fishman, founder of Asym 500, points out that the premium of the six-month VIX relative to the six-month actual volatility of the S&P 500 is currently at a historically rare high level.
Hedge fund Oraclum Capital's Chief Investment Officer Vuk Vukovic remains active in the short-term options market. He stated that moments of market pressure like last Thursday are "favorable for us because when you buy volatility and it explodes, you can achieve the highest returns." He joked last Friday:
"Those who bought put options at the peak yesterday can retire today."
Vukovic noted that option sellers only entered the market last Friday, pushing the VIX lower. He expects volatility to narrow again before Christmas but predicts another spike before the end of the year.
Strengthened Correlation Between Tech Stocks and Bitcoin
The recent decline in tech stocks has coincided with a plunge in Bitcoin, which has seen an increased sensitivity to the Nasdaq 100 index in recent weeks. Vukovic stated, "The correlation with leveraged Nasdaq is very high," referring to funds like ProShares UltraPro QQQ ETF. Wall Street options traders view Bitcoin as a pure risk asset rather than the tool for hedging market volatility that this cryptocurrency was once considered.
Similar to QQQ, the put skew of the iShares Bitcoin Trust ETF is also rising, reflecting increased costs for hedging against declines, indicating that investors are worried about larger drops. This fund, coded IBIT, has seen nearly $2.2 billion flow out in November after attracting over $27.6 billion in inflows this year.
Last Friday, an investor bought $43 put options on the ETF while selling $52 call options to finance this position, hedging against the risk of Bitcoin falling below the early April low. This so-called risk reversal strategy allows traders to sell 10 million shares of IBIT if it drops another 9% in the next four weeks but faces the risk of being forced to short if there is a rebound
The Puzzle Behind the Sell-off
Barclays stock derivatives strategist Stefano Pascale and others described the recent pullback as "quite restrained," but they found it "somewhat puzzling" given the resilience of economic data and strong corporate earnings, particularly from large technology companies. They concluded in last week's report that concerns over the AI bubble and a weakening bullish sentiment among retail investors triggered the sell-off, highlighting worries surrounding capital expenditures.
Later last week, some traders began to cash in on positions betting on higher volatility, which often occurs after significant price fluctuations. According to market participants, over 250,000 VIX December 25/30 call spreads were sold on Thursday and Friday. Based on open interest data, these trades appeared to be closing out positions established in early November.
Former Goldman Sachs strategist Fishman stated in an interview:
"I don't think people are in a rush to cash in on hedges; otherwise, there wouldn't be such a large volatility risk premium. I believe that among all those cashing in on hedges, there may simultaneously be some increasing their protection."
