Options Craze Is Rewriting Rules of VIX, S&P 500 Relationship

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(Bloomberg) — The day-trader obsession with using bullish options to speculate on stocks is doing strange things to the age-old relationship between the U.S. equity market and its benchmark volatility index.

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Rather than move in the opposite direction, as the S&P 500 and Cboe Volatility Index have almost always done for three decades, they went up in unison for two weeks — a stretch of synchronized increases not seen in 14 months.

One common interpretation might be that there is a growing sense of uneasiness as traders bid up the prices of bearish options that in turn lifted the VIX. But an analysis from Susquehanna International Group showed the opposite is true. And that is, investors are flocking to call options to chase gains in stocks like Tesla Inc. and Nvidia Corp., resulting in a spike in upward volatility. The Nasdaq 100 just rose along with the Cboe NDX Volatility Index for three straight weeks, the longest stretch since January 2018.

“The increase in upside volatility has been even more notable, with historically high call skew now priced into the NDX and many of the individual names,” Christopher Jacobson, a strategist with Susquehanna, wrote in a client note. That’s “reflecting demand for upside exposure and a shift in perceived tail risk incrementally away from the downside tail and toward the upside tail, even as the index and the individual names hit new highs.”

The pattern speaks to the rampant fear of missing out among traders who have watched stocks melting up amid better-than-expected earnings and a dovish pivot from major central banks. The S&P 500 was flat at 12:15 p.m. in New York, after rising in 16 of the previous 18 sessions, its best run since 1990. The VIX climbed 4.4% to 17.21.

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The Nasdaq 100 lost 0.2%, weighed down by Tesla as Elon Musk’s Twitter followers voted in favor of selling 10% of his stake in a poll set up by the electric-car chief. Still, the tech-heavy gauge just scored two perfect weeks in a row without a single down day, something that has happened only once before — in 2017.

The Nasdaq 100’s call skew, or a measure of the cost of bullish options, sat at the 98th percentile of its five-year range, according to data compiled by Susquehanna. The pattern of shares up, volatility up is also obvious among some 20 big-tech stocks tracked by Susquehanna. Plotting their implied volatility over time, the firm found that more than half of them saw their call skew sitting in the top 5 percentile of a two-year range.

While other investors may have been behind this options frenzy, one usual player — the retail crowd — is surfacing again. Their force is exemplified by a jump in premium spent on small-lot calls, an indicator widely followed as a gauge for retail interest. According to Options Clearing Corp. data compiled by Susquehanna, small-lot call premiums have surged in recent weeks, approaching the peak reached in January.

The phenomenon was more pronounced among small-cap stocks, noted Credit Suisse Group AG strategists led by Mandy Xu. The one-month implied volatility on the iShares Russell 2000 ETF increased 1.5 points last week while the underlying cash index rallied 6%. Demand for upside calls was so strong that near-dated options cost more than long-dated ones, causing an inversion not seen in at least one year.

The rush for calls lifted the overall average daily volume to 30 million contracts last week, the second-highest in history, data compiled by Bloomberg show.

“The moves have been large and the demand for upside in single stock land insatiable,” said Danny Kirsch, head of options at Cornerstone Macro LLC. “Single stock vols clearly feeding into the index.”

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