Crash or Soar? Investors Get Ready for Stock Market Extremes

Retail investors are showing their longest stretch of bullish options market positioning since 2021’s meme stock craze, according to data from Citadel Securities institutional options desk.

That confidence has investors shedding defenses against a minor correction.

The cost of S&P 500 bullish call options expiring in one year with a 25% chance of coming in the money — known as having a 25-delta — is up, while the cost of equivalent bearish puts is down. Meaning investors are ready for continued broad market advances and aren’t particularly worried about a slight pullback.

They are, however, concerned about a disaster, as positioning for a volatility spike increases.

Average daily call volume on the Cboe Volatility Index, or the VIX, was higher in the first quarter than the two prior quarters. And its two-month skew — measuring the cost of 25-delta calls against equivalent puts — is around its highest level in five years, according to data compiled by Bloomberg.

Investors are “not so concerned with valuations, earnings, or any of the other run of the mill catalysts that could drive a correction,” said Cboe Global Markets Inc.’s Mandy Xu. “Still, there’s a lot of concern of potential black swan events that could send volatility spiking significantly higher.”

A chief risk is the timing and magnitude of interest rate cuts from the Fed this year. Chair Jerome Powell reiterated on Friday that the central bank isn’t rushing to ease policy after the latest inflation data came in line with expectations. Talk of higher-for-longer rates could dent sentiment in the quarter to come.

There’s also the issue of how broad markets fair should the artificial intelligence darlings that have been driving the indexes stall out. “Stretched positioning and technicals” could prompt tech shares to lead the first leg of a potential selloff, Barclays strategists warned in a recent note.

For now, however, those fears are somewhat contained, and hopes for another solid earnings season could drive valuations further into nose-bleed territory. It’s one reason why protective puts are out, and rally-chasing is in.

“Options traders seem much more inclined to buy ‘FOMO insurance,’” said Steve Sosnick, Interactive Brokers chief strategist — calling out the lack of hedging at the broad market level. “But there’s a lot of room between a correction and true tail risk.”