Trading Nation

Traders see less upside for the S&P 500 than ever before

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Key Points
  • Optimism about the potential for serious upside in the next few months appears to have dissipated almost completely.
  • Strategist Stacey Gilbert says the "skew" between call option prices and put prices is the greatest it has ever been since 1990.
  • For investors who remain bullish on stocks, speculating on market upside has never been cheaper.
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Strange signal from the options market

Are stocks more likely to rise by 5 percent over the next three months, or fall by 5 percent?

According to the options market, it is resoundingly more likely that stocks will fall. In fact, put options that would have value in the case of a 5 percent drop cost more than six times as much as call options that would have value in the case of a 5 percent S&P 500 rise.

While puts do tend to cost more than calls, it is unusual to see a difference of this magnitude. In fact, Susquehanna head of derivatives strategy Stacey Gilbert reports that this "skew" between call prices and put prices is the greatest it has ever been, using data going back to 1990. Normally at 2.5, the put/call skew rose to 6.2 this week.

This is not necessarily an indication that investors are getting nervous about the market. To the contrary, those three-month 5-percent-out-of-the-money puts cost less than 1 percent of the price of the index — putting them in the 3rd percentile over the past three years. It's just that those three-month 5-percent-out-of-the-money calls cost less than a fifth of a percentage point, meaning they are at the cheapest level ever recorded by Gilbert's team.

It's no surprise that investors are unwilling to pay much for options, given that actual market volatility is at historic lows. It is striking to note that since the middle of February through Friday's close, the S&P 500 has traded in a range of just 4.1 percent from high to low. That means that the investor who at the market highs bought three-month options speculating on a 5 percent dip, and the investor who at the market lows bought three-month options speculating on a 5 percent rise, both lost money.

The higher price for puts versus calls, then, may simply show that demand for bearish options is less price-reliant than that for bullish ones. This reflects the fact that for many investors, a call is something you buy in hopes of making money, while a put is something you buy in order to hedge your stock holdings. Economics 101 would dictate that out of two goods, the one with the more inelastic demand will maintain its price better.

The bigger story is the one being told by call prices: Optimism about the potential for serious upside in the next few months appears to have dissipated almost completely.

In an interview Tuesday on CNBC's "Trading Nation," Gilbert noted that the risk was seen as "to the upside for a while, when we thought that we would have tax reform, when we thought there was going to be economic growth."

As politically minded optimism surrounding tax cuts and infrastructure spending has faded, however, "it has taken away some of what we would call our 'upside tail,'" or the potential for stocks to see a substantial rise in the near term.

The good news? For those investors who remain bullish on stocks, speculating on market upside has never been cheaper.

On Friday, the CBOE volatility index, which tracks the prices of S&P 500 options, fell below the widely watched 10 level, signaling that more calm is expected in the month ahead. Indeed, it is closing in on the 10-year lows achieved toward the beginning of May.