Market Rally Sparks Fear of Missing Out Among Traders Post-Powell Speech

The rise in the VIX last week signaled that options traders were aggressively buying "out-of-the-money" calls and puts ahead of Federal Reserve Chair Jerome Powell’s speech at Jackson Hole.

In options terminology, an out-of-the-money call has a strike price above the current market level, while an out-of-the-money put has a strike price below. OTM calls only become profitable if the underlying stock or index rises significantly over the strike price. This suggests that traders are placing their bets in a substantial upward movement, betting on prices to increase beyond current levels.

One clear example of this phenomenon was observed as the S&P 500's implied volatility skew evolved between August 20 and August 21. During this period, the S&P index rallied 0.42% while the VIX rose by 0.39 points. The slight lift in at-the-money implied volatilities was overshadowed by increased bids for the deep out-of-the-money (DOTM) wings of the skew, driving up the VIX, RVX, and VXN indices.

This bid for convexity is prevalent across standard expiry contracts for S&P, Russell 2000, and Nasdaq volatility surfaces leading up to the November U.S. Presidential elections.

Moreover, the right side of the volatility smile has seen a much more pronounced increase compared to the left side. This indicates that the demand for OTM calls has surged significantly more than that for out-of-the-money puts. Such a skew suggests that traders are more aggressively positioning for a bullish move, expecting the underlying asset to experience a substantial price rise.

For options expiring within September, open interest is heavily concentrated at strike prices of 5500, 5550, 5600, 5650, and 5700. These "option walls" are significant because they represent levels where large volumes of options contracts are outstanding, indicating potential areas of strong support or resistance.

Charlie McElligott, a strategist at Nomura, highlighted on Monday that the divergence between the S&P 500's rise and the VIX's increase indicates that investors are once again engaging in an "upside grab" in equity index options. As stocks have nearly recovered from the selloff earlier this month, sophisticated investors who initially sat out the recovery are now feeling pressured to buy into bullish options. McElligott had noted a similar trend earlier this year.

CBOE and Nomura aren't the only ones observing this FOMO sentiment. Scott Rubner, managing director for global markets and tactical specialist at Goldman Sachs Group Inc., pointed to strong flows from corporate buybacks and systematic funds that could drive the S&P 500 to a new all-time high this week, further amplifying investors' FOMO.

Goldman Sachs is predicting a “green sweep” for commodity trading advisers (CTAs) over the coming week, implying that these funds will likely be buying stocks regardless of market movements. Additionally, Goldman’s corporate buyback desk experienced its highest demand of the year last week, more than double the same period in 2023. Rubner anticipates strong buying until the quarterly blackout window begins on September 13. Last week also saw $20 billion in inflows to global equities from passive investors.

“We estimate $17 billion of unemotional demand between robots and corporates every day this week,” Rubner wrote in a note to clients on Monday. “There is a very positive three-week equity trading window until Sept. 16.”

“Everyone is going back to the pool,” he added. “US systematic strategies have now overshot exposure to the downside.”