Stocks finished last week higher as implied volatility was crushed. I did not expect that at all. Realized volatility levels have remained above 20, and my thought process was that we would see the VIX stay elevated. Instead, the VIX continued to move lower.
There are many benefits to working for yourself. Among them are flexibility in your schedule and, more importantly, the freedom to be creative. However, one downside is that it’s impossible to remember everything. Over the past two weeks, I underestimated the decay of puts as stock prices rose.
As prices increased, put premiums burned off, causing puts to be closed. Closing puts led implied volatility (IV) to fall, prompting even more puts to close. This created a dual effect: market makers covered hedges, pushing markets higher, and implied volatility declined, helping to further decay put premiums.
As the chart from Optionscharts.io shows, there are no more net put deltas on the board. This doesn’t mean all puts have been closed, but it indicates that all delta positioning is now positive—an oversight on my part. But even Ted Williams, arguably the greatest pure hitter in baseball history, made an out 60% of the time.
With that said, could the market move higher? Anything is possible. However, considering that the options market dynamics are now better balanced, along with other indicators I’ve been monitoring and the technical outlook, the market remains in an area ideal for a potential top. Technically, a 1.5% rally doesn’t significantly alter this view. We are still near the 61.8% retracement level, and retracement levels are rarely exact.
Also, BTIC S&P 500 Total (EPA:TTEF) Return Futures is not confirming this upward move; they made a cycle low on Thursday. In 2022, rallies in the S&P 500 occurred without a rise in leverage cost, and those rallies faded. In contrast, during 2023 and 2024, the leverage cost consistently rose alongside the S&P 500. Currently, the cost of leverage is declining, resembling the pattern observed in 2022 more closely.
After initially moving higher, the JPY 5-year Cross Currency Basis Swap Spread is now turning lower. The key question is whether it will continue downward, and that answer is more complex. However, for now at least, this suggests the rally is likely nearing a turning point.
It appears debatable whether or not CTAs have been active in this rally. Some say they are active, while others suggest they are not. They may be active, as the 20-day moving average appears to be turning upward, and the spread between the 120-day and 20-day moving averages is also rising. Additionally, we’ve seen some sizable market-on-close imbalances, which further indicates possible CTA activity. It could be bullish if they are buyers.