The age-old adage of stocks taking “the escalator up and the elevator down” has been turned on its head in recent years. This adage described the tendency for bull markets to unfold gradually while market corrections often occurred with swift intensity. Yet, the contemporary market landscape paints a very different picture.
Since 2022, we’ve witnessed an inversion – stock prices often skyrocket during single trading sessions, only to steadily decline over an extended period. This analysis, presented by Mandy Xu (head of derivatives market intelligence at Cboe Global Markets) highlights a market phenomenon with far-reaching implications for investors.
Understanding Realized Skew
A key metric in Xu’s analysis is “realized skew.” Unlike implied volatility (reflected in indices like the VIX, which gauge anticipated fluctuations), realized skew measures the actual volatility experienced by the market. Currently, realized skew is trending toward its most negative level in over two decades. A negative skew means upward market moves are more volatile and pronounced than downward ones.
What Does This Unusual Behavior Mean?
This counter-intuitive market dynamic has several possible explanations and consequences:
FOMO-Driven Market: The relentless fear of missing out (FOMO) among investors might be fueling aggressive buying, driving stocks sharply higher in short bursts. This aligns with observations by other experts like Charlie McElligott of Nomura.
Options Market Dynamics: The preference for bullish call options over bearish put options could be a direct response to this inversion. Investors might be anticipating sudden upswings and seeking to capitalize on abrupt rallies.
The Decline of Crashes: 2022’s gradual market decline without significant ‘crashes’ that spike volatility indices like the VIX might have conditioned investors to expect less dramatic downturns.
Navigating the New Volatility Landscape
This unconventional market requires investors to adapt their strategies:
Caution Over Complacency: Explosive but short-lived gains shouldn’t be mistaken for sustainable trends. Remain wary of overpaying just because of the market’s recent behavior.
Focus on Fundamentals: Valuation metrics and solid company foundations become even more important when volatility is hard to predict. Don’t get swept away by short-term swings.
Hedging Strategies: Explore options or other derivative instruments to mitigate risk and protect your portfolio against sudden declines following sharp rises.
Diversification Matters Spreading your investments thoughtfully becomes a key defense mechanism in this uncertain environment.
Important Considerations
While this market inversion is noteworthy, it doesn’t guarantee that severe downturns won’t occur in the future. Market conditions can shift rapidly, so staying informed and flexible is crucial. Past market performance is not indicative of future results.
