Back Derivatives Strategy

Upcoming Catalysts Make Now a Good Time to Own Index Hedges

Published on January 5, 2025

Jeff Jacobson

With the new trading year starting, now looks like a very attractive time to own index (SPY) vol. First, we have seen volatility (VIX) contract sharply from the highs we saw on 12/18 (the day of the last FOMC rate decision and Powell press conference). The VIX index hit a high of over 28 on that day, and after the market rally on Friday it is now back to ~ 16. Also of interest is that 20-day realized volatility is now back near the 4-month highs ~ 16 and up from a low just around 6 before the Dec 18^th FOMC spike. It appears that market volatility is back and likely to stay for a while. In the last two weeks (11 trading days) the S&P (SPY) has averaged a 1-day move of 88bps with 6 of those days having a realized move of at least 86bps.

VIX index has moved back down towards 16 after spiking above 28 on the last FOMC decision day

SPY 20-day realized vol has climbed from a low ~ 6 to ~ 16 (a four month high) thanks to several days in the last two weeks with outsized moves

Given all the known upcoming catalysts, it would appear that volatility is unlikely to move considerably lower until we at least clear some of these potential hurdles. Here is a breakdown of some the potential catalysts that could add further volatility to the market over the next month:

Upcoming Key Economic Data:

ISM Services 1/7
December Payroll Report 1/10
PPI Report 1/14
CPI Report 1/15
Retail Sales 1/16
FOMC Rate Decision 1/29
Core PCE 1/30

Rates continue to be a concern for stocks with the 10-year yield sitting ~ 4.6% and just below the 1-year highs. Clearly each data point could go a long way towards dictating the Fed’s next move when they meet in late January. What does stand out is the disparity between where SPY trades now versus where it was trading the last few times yields were this high. Back in October ’23 when the 10-year spiked to ~ 5% we saw SPY trade down to ~ 410. Then in April of ’24 when the 10-year got to a high ~ 4.7% SPY traded down to a low ~ 495. As we sit here today with the 10-year ~ 4.6% SPY trades at over 590. Therefore, should we see a move to say 4.75% or higher in the 10-year it would stand to reason that SPY could have significant downside risk given where it had traded on previous yield spikes. The inability for bonds to rally the first few days of the year should also be a concern since there should have been an allocation towards bonds given their poor performance in ’24 (especially versus stocks).

The last 2X we saw yields spike to 4.7% or higher (Oct ’23 and April ’24) SPY traded down to 410 and 495. SPY currently trades above 590 and yields are at 8-month highs again

Besides all the economic data and FOMC meeting this month we will also have a new administration come in on Jan 20^th as well as a slew of earnings (starting with the banks next week). Most of the mega cap tech names will report somewhere between the last week of January and the first week of February, and given their large weighting in the index that could go a long way in determining how the market starts the year. So between the move lower in implied vol, the move higher in realized vol, the large amount of economic data we will get before the next FOMC meeting and earnings season there is plenty of reason why owning vol (puts) makes a ton of sense. Whether it is for a portfolio hedge, or a limited-risk bearish bet on the market, I favor owning SPY puts at this time.

Trade:
Buy SPY Feb 7^th 582.50 puts for $5.95 (SPY 591.95 ref)

Trade Details:

Buying the 1-month SPY puts given move lower in vol and large amount of upcoming catalysts in the first month of the year
Puts have a 33-delta and are 1.6% below spot (SPY was 581 on Thursday afternoon)
Targeting a potential break below the recent support ~ 580 after seeing the August uptrend support breaking on the last FOMC meeting on 12/18
Yields at 8-month highs. Stocks have held up very well thus far, but could see meaningful weakness should 10-year get back up to 4.7% or higher
Strong US$ could also start to weigh on sentiment/earnings for the large US multinationals. Should get clarity on that when they report earnings over the next month
Favor the Feb 7^th expiration as that will capture an additional jobs report on 2/7 and some more key tech earnings reports
Suggest buying the outright puts over put spreads as put skew has flattened and vol has come in
Please contact me or the trading desk for updated pricing and execution

SPY broke below Aug uptrend in December. Now targeting a potential break to new lows

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