Following the recent Federal Reserve meeting, macroeconomic volatility showed a notable decline, despite ongoing uncertainty surrounding the central bank's December policy decisions. Both interest rate and foreign exchange volatilities reached their lowest levels in a year, while gold volatility continued its normalization. Conversely, equity and credit volatilities experienced an increase, with the VIX index rising even amidst a broader market rally, a phenomenon sometimes referred to as 'spot up, vol up.' This divergence suggests a complex interplay of factors influencing different asset classes.
A significant development observed last week was the further flattening of the S&P 500 (SPX) skew, a clear indication of hedgers reducing their defensive positions and a corresponding surge in demand for call options. This shift in skew has been quite pronounced over the past fortnight, with the 1-month SPX skew plummeting from its 99th percentile peak three weeks prior to a 6th percentile low before settling at the 48th percentile by week's end. Longer-dated options, such as the 6-month SPX skew, appear even more attractively priced, currently residing in the 16th percentile low. This behavior aligns with an overall increase in optimistic outlook among investors, as evidenced by trends in single-stock options.
The flattening of the index skew is directly consistent with the heightened bullish sentiment permeating individual stock options. A striking statistic is the rise in the number of S&P top 100 stocks exhibiting inverted call skew—a strong signal of extreme optimism—to 20%, significantly above the historical average of 3%. While not yet at the unprecedented levels witnessed in 2021 or late last year, this metric unequivocally points to a substantial degree of investor confidence as the year draws to a close.
These evolving market dynamics underscore a fascinating period for investors. The recalibration of hedging strategies and the discernible uptick in bullish sentiment, particularly in options markets, highlight a collective anticipation of continued positive market performance. However, vigilance remains key, as such concentrated optimism can sometimes precede periods of increased market sensitivity to unexpected events. Navigating these shifts requires a judicious approach, balancing the prevailing optimism with a robust understanding of underlying market risks and potential inflection points.