Your Week’s Volatility Market Commentary — Information Is Your Edge

The Weekly Takeaway:

• The S&P 500 rose by 1.47% for the week despite horrible CPI data on Tuesday and a loss of 0.71%. Thanks goes to a solid day on Monday and a 1.04% gain on Thursday when PPI data was viewed as more benign, leading the S&P to jump 1.04%;
• Stock trading was very slow on Friday with the S&P losing just 0.01% in front of Monday’s President’s Day holiday;
• VolDex (ticker VOLI) fell another 10.57% to close at 11.81 marking the 4th decline in the last 5 weeks although much of this week’s decline can be chalked up to the 3-day weekend. However, the strong performance of the S&P certainly helped drive VolDex lower. We now have to wonder if VolDex is too low for current political and geopolitical conditions as it closed at just the 12th percentile of the 52-week range;
• TailDex (ticker TDEX) once again rose and closed at 13.12 as investors want deep out-of-the-money puts for protection. TailDex closed at the 23rd percentile of its 52-week range;
• The Nasdaq-100 rose 2.90%. VolDex on Nasdaq-100 fell 9.01% and PutDex fell 7.23%. CallDex rose by 4.06%. That all affirms tech’s bullish tone. But TailDex rose by 0.72%;
• VolDex on the individual names we cover was generally lower with only TSLA displaying a rally in VolDex which gained 3.88%. TSLA is up 88.56% over the past 52-weeks but is down 10.22% over the past month;
• The Nations Investor Optimism Index rose 46.43% to close at 44.47.

Equity Index Volatility:

The market’s worst fears about prospects for further rate cuts on the part of the Fed were stoked on Wednesday when CPI showed a monthly gain of 0.5% versus consensus estimates of a gain of 0.3%. Add anecdotal news about the cost of eggs and gasoline and the market sold off with the S&P down 1.08% at its low of the day before rallying to close down just 0.71%.

The S&P rallied 1.04% on Thursday as investors chose to look at that morning’s PPI data in the best light and traders seemed to take an extra long weekend with very little action on Friday.

Interestingly, there were two volatility metrics in the S&P which were higher on the week: CallDex, which gained 9.04%, and TailDex, which gained 3.22%. What does that tell us? Out-of-the-money call option buyers are back and investors are willing to buy deep out-of-the-money puts at these levels to hedge against a “tail event” or dramatic break in prices. The first is moderately bullish (if these call buyers were really bullish they’d just be buying stocks and while there’s plenty of that, some bulls are defining their risk by buying calls instead) and the second shows the simple acknowledgement that these hedging puts are reasonably priced (18th percentile of the 52-week range) and there are several reasons to worry.

Why It Matters…Volatility is still painting a market landscape that is decidedly bullish. Can stocks still go down? Certainly but that would surprise the S&P option market.

VolDex on the Nasdaq-100 fell again and closed at 16.49, down another 9.01% on the week and is now at just the 13th percentile of its 52-week range. PutDex fell 7.23% showing that fear is ebbing as the inflation catalysts passed and with most of the earnings releases for Q4 in the rearview mirror. A note, NVDA is due to report on February 26 so our 30-day Dexes capture that release although our 7-day Dexes don’t capture it yet.

Interestingly, call option buyers are back in the Nasdaq-100 as they are in the S&P with Nasdaq-100 CallDex gaining 4.06% despite the 3-day weekend. It closed the week at the 22nd percentile of its 52-week range so call buying strategies can still be executed at attractive prices for those who are bullish but who want defined-risk strategies.

It remains worth noting that RiskDex, which is the ratio of out-of-the-money put prices (as measured by PutDex) to out-of-the-money call prices (as measured by CallDex) remains much lower in the Nasdaq-100 (2.60) and the Russell 2000 (1.65) than it does in the S&P 500 (3.31). This is a function of systematic call selling strategies in the S&P and a lack of the same in the Nasdaq-100 as few investors are willing to truncate upside. In the Russell 2000 it seems that call selling strategies just haven’t taken hold.

Why It Matters…There is an opportunity for sophisticated traders to take advantage of this difference while defining risk by replacing outright short call options with call spreads and outright short put options with put spreads. Buying put spreads rather than outright put options not only reduces the cost of the trade (at the cost of potentially truncating return) but also takes advantage of put option skew.

A note: the dramatic decline in 1-day and 7-Day measures is due largely to the 3-day weekend. Don’t read too much into it.

In the comparison chart of PutDex and CallDex below you can see how CallDex has arrested its decline and has rebounded slightly.

Why It Matters…Systematic call selling products focused on the S&P 500 have driven out-of-the-money call option prices down versus their ultimate value. The difference between the cost of an option (implied volatility) and the ultimate value of the option from now until expiration (realized volatility) is called the Volatility Risk Premium and it is usually positive in that, over time, options cost more than they’re ultimately worth. This makes sense since the option seller can only make the premium received while their potential losses are very large and potentially unlimited in the case of a call option. So like typical insurance, the seller demands a margin in the form of the volatility risk premium.

But the systematic covered call selling ETFs and similar products in other wrappers, have pushed the price of out-of-the-money calls down to a point that is very close to their ultimate value over time. Below you can see a chart of the S&P 500 CallDex since its inception in 2005.

With Friday’s close of 15.41, 30-day CallDex on the S&P 500 is now at just the 12th percentile of its entire history. This is an environment that the savvy trader can take advantage of.

Nations Investor Optimism Index:

The Investor Optimism Index rose by 46.43% to end the week at 44.47. That is still very mildly bearish as we need to see the index above 50.00 before we can say traders are bullish.

For the history of the Investor Optimism index going back to 2007, the average gain for the S&P 500 Total Return Index over the next 20 trading days when the Investor Optimism index closes between 40 and 50 is 1.28%. That’s higher than all other 10-point ranges with the exception of when the index is below 10 (gain of 2.04% over the subsequent 20 trading days).

The Optimism Index is calculated using the 2-year range for VolDex, RiskDex, and TailDex and signals less fear and more optimism when those measures, and option prices, are low and less optimism, as it is signaling now, when those measures are relatively high.

Why It Matters…Our Optimism Index can be used as a contrarian indicator for BOTH equity prices and option prices. Any level below 20 can be considered a contrarian “Buy” signal in the S&P 500 as the average subsequent 20-day total return when the Investor Optimism Index is below 20.00 is 1.49%.

The average return for all 20-day periods since 2007, when Investor Optimism data begins, is 0.90%. But for 20-day periods subsequent to the Index closing between 60 and 90, the gain is just 0.65%. For 20-day periods subsequent to the Index closing at or below 20, the gain is more than double that at 1.48%.

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Deconstructing Skew:

Last week saw uniform selling of nearly all strikes. We have to get very close to 1.00 standard deviations above at-the-money (approximately 16 delta) to see higher option prices as signified by black meaning the constant 30-day option price at that moneyness was higher on the week.

Other Equity Indexes:

As we have discussed, the Nasdaq-100 enjoyed a substantial gain of 2.90% on the week as fears about DeepSeek upending the AI market eased. Several of the individual names we covered did even better with AAPL leading the way (+7.46%). .

We don’t discuss the Russell 2000 very often but this week’s volatility action is worth noting. Russell 2000 VolDex closed at just 18.33, the 10th percentile, and 7-day VolDex closed at 14.17, just the 5th percentile. Even after accounting for the 3-day weekend, that vol level is very cheap.

Why It Matters…The beauty of adding options to your quiver of trading tools is the ability to create payoff profiles that are unique and which can’t be crafted without using options. Also, it allows you to build long option trade structures which are less likely than not to be profitable but which still have positive expected value because of convexity. This may be one of those times regarding options in the Russell 2000.

Other Asset Volatility:

Treasury Bonds:

Our Dexes on treasury bonds fell across the skew and tenors this week with the exception of a small gain in 30-day CallDex (+5.31%). Volatility eased as the 10-year treasury yield fell by 1.5 basis points on the week and closed at 4.47% after spiking to an intraday value of 4.66% on Tuesday following the CPI data.

That call option prices (CallDex) rose slightly while all other option prices fell suggests bond option traders have renewed confidence that the Fed will maintain its rate easing cycle until the end of the year. PutDex is at just the 9th percentile of its 52-week range and TailDex on treasury bonds closed on Friday at a brand new 52-week closing low.

Treasury bond PutDex was relatively low but TailDex was even lower.

It is also worth noting that Treasury Bond RiskDex closed the week at just 0.85 meaning calls are now substantially more expensive than puts.

Why It Matters…Treasury bond option prices are generally the purview of institutional traders but anyone who is bearish on TLT, the long-bond ETF, can use a call spread risk reversal to get downside exposure while defining risk and using the call skew in TLT to their advantage.

Bitcoin:

VolDex on bitcoin fell slightly on the week so our previous remark that “Defined-risk positions which are short volatility in bitcoin continue to make sense” worked out.

Bitcoin VolDex continues to fall and is clearly looking for its equilibrium level. That is likely to be below the current 50 level until we see another strong trend develop in bitcoin prices.

0DTE and 1DTE Options:

Zero day to expiration (ODTE) options continued to account for the majority of SPY option volume, with 56.74% of this week’s SPY option trading being 0DTE. It is worth noting that 0DTE SPY volume as a percentage of total SPY volume no longer dips on those days when the market is down substantially. For example, on Wednesday, when the S&P was down 1.08% at one point, 0DTE volume was 56.89% of all SPY volume, slightly above the average for the entire week (56.74%).

Very short-dated volatility measures which use a variance swap methodology, as 1-day VIX does, inject significant error into the resulting measure because of the way out-of-the-money options trade in the hours before expiration. The VolDex at-the-money methodology is particularly suited for these very short-dated tenors.

Equities:

This week’s news was generally good for the individual names we cover as several name had substantial gains and the losers sustained very light loses.

VolDex fell for all these names with the exception of TSLA which continues to come back to earth following its price spike in November and December of last year.

But you’ll note that the volatility picture in TSLA was pretty nuanced last week with CallDex rising and PutDex falling slightly, meaning the volatility picture is not purely bearish. We discount most of the decline in 7-day Dexes given the 3-day weekend.

Scott’s Weekly Commentary:

It appeared that a general feeling that inflation is no longer falling, and might actually be ticking up, was going to be buttressed by actual data when CPI came in higher than expected on Tuesday. The stock market fell, as we’ve discussed above, but the decline in the S&P stopped midday at 1.08%, a moderate decline, before recovering one-third of that loss.

This means we’re back to traders taking any opportunity to buy dips and this has certainly been a profitable strategy since October 2022. Even if you’re dubious about the economic and geopolitical situation, and that’s perfectly reasonable, it doesn’t make much sense to argue with a profitable strategy as long as you’re watching risk and using options in a sensible way. For ex-ample, if you’re selling puts you had better be ready and able to buy the stock if it is put to you at expiration.

NVDA earnings on February 26 will be critical for the market and in thinking about the performance of the AI-focused names during the current cycle, I’ll be focused on the forward guidance more so than EPS and revenue.
Monday is a holiday and the rest of next week lacks big data releases so politics and geopolitics will weigh heavily. I still believe we’ll hear plenty of talk about tariffs, and “retaliatory tariffs” are in the news now, but I believe the talk will continue to be a negotiating tactic that is the starting point for other concessions. Any “real” tariffs that are actually implemented will change my calculus.

Everyone at Nations Indexes hopes you have a great and profitable week!

Scott