Has the ‘dumb’ money moniker been switched? And is the top in now in the US equities market?

2 mins. to read

News that the biggest hedge funds have suddenly turned bullish as the S&P probes new all time highs certainly caught my eye. Typically it is retail investors that rush in at the top while “smart” funds sell into them. Not this time…

The options market is sending a message that the market will keep rallying to new record highs.

Major hedge funds are reportedly buying, or have bought, massive amounts of Standard & Poor’s 500 index calls in the over-the-counter options market. The calls would increase in value if the index, now at about 1,664, rises to 1,725 by year’s end. The funds reportedly missed the stock market’s rally and are playing a vicious game of catch-up.

Though it is difficult, if not impossible, to penetrate the veil of secrecy that surrounds the OTC markets, evidence in the listed options market suggests investors are clamoring to buy bullish calls.

The CBOE Volatility Index (VIX), which should decline when stock prices rise, is increasing. Traders said the unusual behavior means that the banks selling OTC calls to big hedge funds are buying the VIX to hedge their positions.

Also, evidence suggests that big funds are not alone in making bullish bets in the options market.

The implied volatility of August calls on the S&P 500 – essentially the options market’s expectation that a security’s price will change – has sharply increased since March.

At the end of the first quarter, investors could buy bullish S&P 500 calls without paying a greed premium because expectations were low that the stock market would advance. Now, the price of August calls on the S&P has surged by as much as 100% by some measurements, according to one strategist.

The change in options market pricing dynamics is a big development. Since the 2007 financial crisis, bearish puts have largely been more expensive than bullish calls, reflecting investor fear about the future of the stock market. The fact that the implied volatility of calls is now increasingly more expensive than puts is a milestone in the stock market’s recovery from its crisis lows. This could just be the final signal to take your money and run and take advantage of the so called “call skew” and position for a sharp decline.

The idea that the stock market will continue to advance is more than a reflection of options trading patterns. Goldman Sachs’ portfolio strategists Tuesday raised their 2013 target price for the S&P 500 to 1,750, from 1,625, as the economy improves faster than expected, and companies increase their dividend payouts. The strategists, David Kostin and Stuart Kaiser, expect the index will rise to 1,900 for 2014, and 2,100 for 2015.

If the Vampre squid says Buy you typically want to sell as they are usually on the selling side and vice versa.

Comments (0)

Comments are closed.