Forward Note - 2025/02/09
Monday Rollercoasters.
Two big Monday gaps down in a row—definitely not on our bingo card. Neither was the speedy recovery each time, steadily pushing us back toward all-time highs as the week progressed. In the end, the S&P 500 closed relatively flat, and the VIX settled at 16.54 after a slightly disappointing jobs report, but it certainly felt like the market managed to dodge not one, but two bullets.
The first shiver ran through the market last Friday afternoon, when Trump announced 25% tariffs on his neighbors and 10% on China. Yet, after a friendly conversation with Mexico’s newly elected president—and a promise to deploy 10,000 soldiers to patrol the border and crack down on fentanyl trafficking—the 25% tariff was pushed back by a month.
That was enough to rekindle the mood in stocks—50 handles in just four minutes on the S&P 500—a move later reinforced by news of yet another "friendly conversation," this time with Canada's soon-to-be former Prime Minister, delaying tariffs there by a month as well.
Once again, good luck delta hedging as a retail trader. But if we put direction aside, this is yet another reminder that when we called for buying wings in 2025, we meant both sides—not just puts. Call prices in stock indices are naturally depressed for a variety of reasons, but that effect is even more pronounced when the variance risk premium (VRP) is as compressed as it has been lately.
When realized volatility is elevated like this in equity indices, buying calls is often a better value proposition than selling depressed puts. Here’s a quick look at our skew index, which compares the price of out-of-the-money calls to out-of-the-money puts:
A high value would indicate that puts are in significantly higher demand than calls. But despite all the recent market shenanigans, the data shows that puts are not exactly a hot commodity in the S&P 500—except, of course, on Monday morning pre-market, when market participants briefly realized that things could go south fast and they might not be fully covered against a 5% drop in the index.
The skew term structure is even more revealing. While puts were still well-bid after the FOMC and again on the Monday post-DeepSeek, that wasn’t the case this week. In fact, compared to June 2024—when markets were all sunshine and rainbows, blissfully unaware of the disruptions that would unfold over the next six months—there’s barely any difference, except on the longer tenures.
Now, when you contrast that with the current variance risk premium (VRP) in SPY across the maturity cycle, a few immediate conclusions emerge:
This chart should make you think twice before selling options in SPX right now, especially on the short end. But when combined with the Skew Index, it also highlights something important—calls are cheap.
Now, if Monday morning brings yet another wave of market indigestion (say, because Kendrick Lamar single-handedly takes over the entire rap game during the Super Bowl halftime show), and the market drops another 3%, then selling puts could become interesting—but only if their implied volatility spikes well above 17.
However, the best position might be to focus on buying the depressed calls in the front month.
We can already hear the objections from a mile away:
“Yeah, but theta decay will eat you alive.”
“Moving averages support the index, so puts get tested but rarely exercised.”
Sure, there’s no guarantee your call ever ends up in the money—but that’s missing the bigger point.
We’re simply saying that, rationally speaking, calls are a better and cheaper bet on SPX’s terminal distribution a week from now. Gamma is cheap—as seen in how depressed the short-term VRP is—and as the last two weeks have shown, the market is eager to latch onto any excuse to rally back hard and erase its losses.
Of course, watching your account bleed a little bit of theta every day isn’t exactly fun. Having something expensive to offset those calls would make things a bit easier.
Last week, we highlighted how Chinese equity volatility was trading at a hefty premium relative to realized risk in the underlying. But that’s not the only place where the market is paying up for volatility—Gold, for instance, is carrying quite a bit of VRP around the 30-day tenor.
The issue with this strategy is that gold and equities may not move in perfect sync, and the worst-case scenario—GLD volatility exploding while SPX melts down—isn’t exactly far-fetched.
Instead, you could consider a variation of the trade we outlined in our last Forward Note: selling VXX puts. As many retail traders have pointed out, VIX ETNs have been unusually resilient, a trend that started pre-election when the VIX futures term structure flattened out and began acting as a buffer against the usual roll-down decay in these products.
If you believe the VX term structure will hold this shape for a while, your VXX puts remain well protected. And if volatility spikes, your calls may expire worthless, but you’d still pocket the premium from the insurance you sold.
In other news
Are we at the start of a great reversal in the Yen?
The Bank of Japan has made it clear: the economy has exited its decades-long period of deflation—or at least stagflation, depending on how you frame it. With inflation hitting 3.6% in December 2024 year-over-year, the days of desperate price stimulation feel long gone. Instead, Japan is now on a path to raising rates, trying to tame inflation and bring it back to the 2% target.
Once again, we won’t pretend to be economists, so we won’t go too deep into policy speculation. However, if markets start pricing in Fed rate cuts this year, the great Yen reversal may not be too far off. In any case, JPY hit its highest levels against a basket of currencies this week, and it’ll be interesting to see if this move has more legs.
Thank you for sticking with us until the end. As usual, here are a couple of good reads from this week:
We’re usually cautious when
shares their views, but their latest piece on Trump, tariffs, and most importantly, how to trade around both, is top-notch. Oh, and it's free this week.Back when we were naïve and unwise business school students, we daydreamed about having access to a Bloomberg terminal—the holy grail that meant you had “made it” in financial markets. A decade and a half later? We haven’t used one in years, and aside from checking prices on chat, what truly makes Bloomberg such a special company? A great article from a fascinating publication,
, sitting at the intersection of finance, data, and technology dives into exactly that.
That’s it for us this week. We wish you a not-too-hot, not-too-cold CPI week ahead. Happy trading!
Oh, and what’s a financial content creator’s Achilles’ heel? Their ego—it’s anything but antifragile.
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