Think Wall Street’s back to normal? Not so fast, options markets say

NEW YORK (Reuters) – Options investors are preparing for more volatility ahead despite last month’s sharp rebound in U.S. stocks, reflecting doubts that markets will be quick to return to their former highs in the middle of the coronavirus pandemic.

Market turbulence has plunged alongside stocks’ climb since late March, with the Cboe Volatility Index , known as “Wall Street’s fear gauge,” last at 37.19 on Friday after peaking above 80 in mid-March. The S&P 500 .SPX rose 12.7{3c4481f38fc19dde56b7b1f4329b509c88239ba5565146922180ec5012de023f} in April, its biggest monthly percentage gain since 1987, and has climbed more than 27{3c4481f38fc19dde56b7b1f4329b509c88239ba5565146922180ec5012de023f} from its March 23 closing low.

In another bullish sign, the front end of the S&P 500 volatility term structure, which plots volatility expectations over time, is no longer inverted, suggesting that worries over a near-term stock reversal are subsiding.

But while the lightning-quick rebound has taken the S&P to within 16{3c4481f38fc19dde56b7b1f4329b509c88239ba5565146922180ec5012de023f} of its all-time high, some investors are betting market gyrations may return in coming months as the economic consequences of the coronavirus become more apparent. Those wagers run counter to the expectations of more bullish market participants, who believe stocks are unlikely to revisit their March lows.

“There’s more systemic risk being priced, which would be more consistent with concerns over an economic recession,” said Benjamin Bowler, global head of equity derivatives research at Bank of America.

Expectations of more volatility to come are partially reflected in the VIX, which is still comparatively high – the index stood at less than half its current level in late February, before worries over the coronavirus’s spread outside of China shattered a months-long period of relative market calm.

And medium- and long-term VIX futures have risen over the past month, indicating that investors expect markets to remain volatile despite April’s dramatic rally.

Such longer-term volatility would be consistent with past global crises, when markets were hit with multiple waves of selling over many months, investors said.

“To us, it doesn’t feel like a true risk-on-type environment,” said Matt Thompson, managing partner at options firm Thompson Capital Management.

Possible triggers for such turbulence run the gamut from a resurgence in cases of COVID-19, the disease caused by the novel coronavirus, signs that the U.S. economy has taken a worse-than-expected hit from shutdowns across the country, or political risk tied to the U.S. presidential election later this year.

Investors are also continuing to hoard put options, used for downside protection, despite the market rally. Over the past few weeks, skew, a measure of demand for puts versus calls, which are used for upside positioning, has risen on the SPDR S&P 500 ETF Trust (SPY.P), a popular exchange-traded fund that tracks the S&P 500.

Volatility markets are behaving similarly to past global economic shocks, such as the global financial crisis of 2007-2009 and the Greek debt crisis of 2011, Thompson said. The S&P 500 took about 10 months to return to its 2011 highs after the Greek debt crisis and more than five years to mark fresh record highs after the global financial crisis.

“Going back to the financial crisis, a VIX of 20 or 30 was relatively normal,” said Jon Cherry, head of options at Northern Trust Capital Markets. “That’s the neighborhood we live in today.”