(Bloomberg) -- A sign of stability is emerging after the S&P 500 Index plunged into one of its sharpest-ever corrections: Traders are ditching bets that another deep slide is ahead.
Even before the benchmark for US equities rebounded strongly on Friday, the group was largely offloading its S&P 500 hedges. The cost of options protecting against a 10% decline in the SPDR S&P 500 ETF Trust in the next three months plunged to near the lowest level since 2023 relative to contracts that profit from a 10% rally, data compiled by Bloomberg show.
While perhaps falling short of a full vote of confidence that the S&P 500 will extend its Friday rebound, the fact that options pros are cashing out their downside hedges may give solace to those trying to gauge whether the selling pressure has abated. After posting the seventh-fastest 10% decline from a record, the S&P 500 gained 2.1% on Friday.
“We might see a little bit of a stabilization period at least into next week until maybe things get shaken up,” Alon Rosin, head of institutional equity derivatives at Oppenheimer & Co. said on Friday.
The recent stock selloff has left traders conflicted on the key debate that’s gripping the investment world right now — whether the moment has come to buy the dip.
Concerns about the economic impact of a trade war sparked by President Donald Trump led some to wait on the sidelines and lock in profits. On the other hand, retail traders are still optimistic and used the decline to boost their exposure to stocks.
VIX Signal
Another potentially bullish signal some investors are turning to is Wall Street’s fear gauge.
Elevated levels of panic, as seen in the Cboe Volatility Index or VIX, tend to correspond with better S&P 500 performance in the following month, according to Bloomberg Intelligence. That’s because a higher VIX reading means the market has already sold off and could bounce back as traders pile into cheaper stocks.
The VIX peaked last week just shy of 30 on an intraday basis, the highest since August, putting it in the most elevated of the 10 tiers that BI used in its breakdown. In BI’s analysis, when the gauge reaches that most volatile decile, the S&P 500’s median return is estimated to be around 2.66% for the next month. The calculations bode well for investors keen on dipping back into equities.
Of course, neither the cost of downside protection declining nor the elevated VIX are foolproof signs that the worst is over for stocks. Other ETFs are signaling that demand for downside protection through put options persists. For the VanEck Semiconductor ETF, it’s actually been growing in recent days on a net basis, showing that at least some traders aren’t confident the bottom is in.
The connection between higher VIX levels and S&P 500 outperformance over the next month may also be tenuous as it has a 63.5% hit rate, according to Bloomberg Intelligence. Additionally, at least one indicator, based on a century-old theory, is signaling more pain ahead for US stocks.
Even so, the fact that at least some traders are less interested in protection against further declines indicates that they have some faith of that Friday’s stock rebound will hold.
The shift in options demand is a “possible ‘tell’” that things are stabilizing, said Steve Sosnick, chief strategist at Interactive Brokers.
Still, he’s not fully convinced that the bottom is in after just one day of market strength.
While Friday was “certainly a solid day, we haven’t seen a true capitulation.”
