Fear of the Fed Fuels Frantic Volatility Spike – For Awhile

This week’s equity index volatility action was defined by Wednesday’s collapse in equity prices with the S&P losing 2.95% that day as VOLI gained 46.0%. Interestingly, VIX gained 74.3%. The divergence between VOLI and VIX is explained by the day’s 128.46% increase in TDEX, TailDex on
SPY.

You can see the 52-week chart of VOLI in Chart 1 and the 52-week chart of TDEX in Chart 2. The drop in equity prices was due to the Federal Reserve Chair Jay Powell lowering expectations for rate cutting in 2025 as inflation remains stubbornly high, unemployment is happily low (4.2%), and economic growth remains robust (GDP annualized growth of 2.8% in Q3).

Wednesday’s divergence in option prices is why we say you have to deconstruct skew to really understand what option markets are saying. By looking at that increase in TDEX, only the 8th time in its history that it has gained more than 100% in a single day, and the much smaller increase in VOLI, it’s possible to know that deep out-of-the-money put options were behind much of that increase in VIX.

WHY IT MATTERS…knowing which options are driving VIX explains what market participants are thinking. If an increase in VIX is driven by call buying then bullish sentiment is increasing – that’s likely good for equity prices. If an increase in VIX is driven by at-the-money option prices (i.e., VOLI), then we can assume there is concern and investors want hedges for protection but they don’t expect a dramatic decline.

On the other hand, if an increase in VIX is driven by an outsize increase in deep out-of the-money put options (i.e., TDEX), as it was on Wednesday, then traders and investors think there is a high likelihood of a “tail event” which would be a substantial drop in equity prices.

For the week, equity index option prices and implied volatility rose as the S&P fell 1.99%. VOLI gained 39.05% to close at 14.34. TDEX gained 34.74% on the week to close at 18.27, only because much of Wednesday’s gain was taken back on Thursday and Friday.

PutDex gained 40.92% as everyone wanted to but puts. CallDex fell 20.59%, likely from traders selling calls to get short exposure as well as bulls who were long calls for a directional bet and who threw in the towel in the last half of the week.

You can see PutDex and CallDex in Chart 4 and RiskDex, which closed at an extreme of 5.74 on Thursday. The worst of the damage was repaired by Friday’s rally of 1.09% in the S&P 500. Credit goes to Personal Consumption Expenditures (PCE) index data showing that inflation is easing (the increase in November was just 0.1% while the market was expecting 0.2%).

Longer-dated S&P implied volatility increased as well on the week, as would be expected. 90-Day VolDex closed at 15.01, an increase of 16.90% while 360-Day VolDex closed at 16.39, an increase of 5.36%. You can see the week’s term structure in Chart 6.

VolDex on the Nasdaq-100

rose by 32.12% during the week to close at 18.92 as the Nasdaq-100 lost 491.10 points or 2.25%. Friday’s close for Nasdaq-100 VolDex is at the 24th percentile of the past 52 weeks so it is still relatively low as you can see in Chart 10. The Nasdaq-100 index has outperformed all the other major indexes this year, gaining 26.53% YTD vs. 24.34% for the S&P 500.

WHY IT MATTERS…While VolDex on the Nasdaq-100 has increased since the very low level 2 weeks ago, it is still reasonably priced thanks to the continued bullish tenor of the market and the looming holiday period. Traders can use at-the-money QQQ options to express a point of view while at these levels and investors can place hedges to protect very generous gains.

CallDex, PutDex, and RiskDex on Nasdaq100 CallDex fell to 22.83, a decline of 15.34% on the week as traders sold out-of-the-money calls to get short exposure to the Nasdaq-100.

This is a new 52-week low! Investors who want to use out-of-the-money calls for stock replacement in order to get continued upside exposure with limited downside have never had a better opportunity this year.

PutDex and TailDex rallied strongly as we would expect given the turmoil in stocks and the fact that in a sell-off it’s normal to see the biggest names sold first (and the biggest names in the Nasdaq-100 are the biggest names in the broad market) because they are considered the most liquid meaning market impact costs are expected to be low.

They also tend to be sold first because right now they all show very nice gains for the year and the disposition effect describes the tendency for investors to sell their winners first.

VolDex on treasury bonds

rose by 9.12% for the week, as you can see in Chart 14. As we pointed out last week, TLT option prices were very low with VolDex in the lower-third of its 52-week range.

Readers who took advantage of those low option prices in the face of the Fed meeting and Friday’s PCE inflation data were well rewarded.

Even at Friday’s closing level of 14.52, VolDex on treasury bonds is at just the 38th percentile for the past 52-weeks meaning option prices

are still relatively low. Traders can and should take advantage of this.

Both CallDex and PutDex on TLT gained on the week (2.75% and 14.68% respectively) but as with VolDex, these are rallying from low levels as you can see in Chart 15.

WHY IT MATTERS…As we said last week, treasury bond prices are likely to become very volatile if the market begins to rethink its optimistic outlook for rates in the first half of 2025 and that’s exactly what happened after Jay Powell’s presser.

PutDex on treasury bonds is still in the bottom half of its 52-week range so there is a wide range of intelligent trade structures available.

Treasury Bond out-of-the-money call option prices are cheap with CallDex at the 23rd percentile of the 52-week range and SpikeDex, an important measure of deep OTM call option prices, at just the 14th percentile of its 52-week range. It is tough to imagine scenarios wherein treasury bond prices strengthen considerably but that may be the best reason to buy calls while they’re cheap.

VolDex on gold

fell slightly to close at 13.90 as you can see in Chart 19, but put option prices rose. PutDex rose 9.23% to close at 40.35 and TailDex rose 62.05% to close at 6.99.

Put prices in gold are now historically high; PutDex is at the 66th percentile of its 52-week range and TailDex is at the 88th percentile. TailDex made a new 52-week high of 7.75 on Tuesday.

As a result of these moves, RiskDex for gold now shows a small amount of put skew meaning option markets believe the implied downside for gold is slightly greater than the implied upside.

WHY IT MATTERS…since put and call prices on gold are near parity, they can be used to express directional opinions. For example, a gold bull could sell an out-of-the-money put option and use the proceeds to buy an out-of-the money call option.

This structure is called a risk reversal and offers bullish exposure although using a risk reversal means potentially having to buy gold if the price of gold is below the strike price of the put option sold near option expiration.

Gold bears could do the reverse although we would never suggest selling a naked call option so bears might sell a call vertical spread and use the proceeds to buy a put option. We’re continuing to watch the unusual price action in both SpikeDex and TailDex in gold with considerable interest.

You can see both in Chart 21. As we said last week: “Traders see much more relative downside than potential upside to gold for the next 30 days.” During the week, gold prices did indeed fall by 1.15% and puts got more expensive while deep out-of-the-money calls got cheaper even after accounting for strike price.

VolDex on Bitcoin

is new with the advent of spot Bitcoin ETFs such as IBIT which is the underlying used for Nations Bitcoin volatility and option cost measures.

Bitcoin VolDex is extremely high relative to other asset classes, commensurate with the potential for volatility in bitcoin prices, and it closed the week at 61.41, an increase of 4.28%. CallDex rose by 8.95% and PutDex rose by 28.42%. RiskDex closed at 0.95, up from just 0.81, so out-of-the-money puts and calls are nearly at parity; the significant call skew we saw just last week has disappeared.

Implied upside is now only slightly greater than implied downside. The bitcoin option market continues to evolve but there are not currently sufficient strike prices to calculate TailDex and SpikeDex.

We’ll continue to press exchanges to add more strike prices in bitcoin.

WHY IT MATTERS…It would be easy to look at the Dexes for bitcoin and think options are very expensive, and they are with VolDex above 61 and both CallDex and PutDex well above 175.

While it is difficult to create profitable trade structures that are long options when option prices are this high, there are other opportunities.

But first, just how expensive are bitcoin options?

Diving into the VolDex methodology we learn that a 30-day straddle (buying both an at-the-money call and an at-the-money put) in bitcoin would cost about 14% of the cost of the underlying (IBIT is the bitcoin underlying for Nations Bitcoin indexes). That’s more than 4-times more expensive than a 30-day straddle in SPY.

But selling options can generate significant risk. We suggest selling defined-risk option spreads in bitcoin as the best way to profit from directional trades while collecting premium and at the same time defining risk. For example, in IBIT, which closed the week at $54.81, in the January expiration, it was possible to sell the 52/50 put spread (selling the Jan 52 put and buying the Jan 50 put to limit risk) at $0.60 on Friday’s close. That $0.60 would be the maximum profit on the trade and the maximum loss would be $1.40 if IBIT is at or below $50.00 when the options expire on January 17.

But that would require IBIT to fall by 8.8% during that period. We use our indexes to identify the best sort of trade structures – in this case our indexes describe very expensive options so a defined risk position that takes advantage of that is the place to start.