S&P 500 hedge costs soar! Investors go crazy buying put options, strategists urge "to be greedy when others are fearful"

Notice that the S&P 500 index has been in a range-bound trend for almost four months, with investors willing to pay high premiums to hedge against the possibility of the next major downward break. However, for an increasing number of strategists, this pessimistic sentiment is actually a reason to anticipate a reversal in the market's direction. Changes in market sentiment, especially among retail investors, have occurred against a backdrop where the S&P 500 index has mostly been fluctuating below 7000 points this year, breaking expectations of an imminent upward breakout. The market stagnation has its reasons: artificial intelligence tools have triggered large-scale sell-offs in multiple industries, trade policies remain uncertain, and geopolitical tensions continue to run high. Amid a series of negative factors, investors are flocking to derivative markets, buying positions that will profit from heavy losses in the S&P 500 index. The ratio of put-to-call skew, which measures the cost of downside protection versus upside bets, surged to a two-year high last week. Currently, the two-month skew on the normalized S&P 500 index is nearing the upper end of its five-year range. The one-month standardized put option skew reached its highest level in over a year. Typically, when market sentiment becomes overly skewed in one direction, strategists start to notice signals of a reversal. Stuart Kaiser, head of equity trading strategy at Citi Group, said, "We're seeing a lot of money flowing into very short-term tactical hedging tools. In the past 6 to 12 months, the stock market hasn't reacted significantly to most geopolitical events. If the Iran risk subsides, a lot of risk premium will be squeezed out of the market, and investors who have been on the sidelines holding cash will start entering the market long." Supporting this view are related data. A measure tracking ETF fund flows and leveraged indicators such as futures-based hedge fund strategies at BNP Paribas has fallen to its lowest point since November last year. Contrary to intuition, these bearish positions configurations often serve as a buy signal. Greg Butler, head of U.S. equity and derivatives strategies at BNP Paribas, said, "Over the next few weeks, you might see a rebound led by tech giants. This could easily push the S&P index to 7,000 points, a psychological barrier the index has struggled to breach. This breakthrough could then force some capital into the market." Butler named his latest market newsletter "Greed While Others Fear," noting that the rebound following Nvidia's earnings release could pave the way for a sprint to 7,000 points on the S&P 500 index. Bank of America analysts argued this week that a simple way to trade the uptrend in tech stocks is by purchasing call spread options on the Invesco QQQ Trust ETF. Nvidia's earnings report on Wednesday night provided potential fuel for the bulls. The chipmaker released revenue forecasts that exceeded expectations, and profits that surpassed expectations, at least temporarily easing concerns that AI spend is becoming a financial burden. Regardless of Nvidia's performance, more support may be needed for the stock market to send a fully reassuring signal. Retail investors who have reliably bought on dips in the past few years are showing signs of fatigue. Data compiled by Citi shows that non-professional investors accounted for 8.3% of total stock trading volume last week, compared to an average of 11.7% last year. Earlier this year, their participation levels even dropped to the lowest point since 2024. "Retail trading volume has collapsed," Kaiser said. "These investors have indeed retreated." With the U.S. amassing military forces near Iran, geopolitical risks persist. Any hostile action in that region could disrupt global energy markets and make investors more concerned about geopolitical risks now compared to recent times. For the bulls, this pessimistic sentiment actually creates buying opportunities.