Analysis: Massive reversal in stocks puts traders on alert for more volatility

NEW YORK, Oct 13 (Reuters) – A dramatic reversal in stocks could be less bullish than expected, with traders saying short-term hedging activity has supported stocks while leaving gloomy market fundamentals unchanged.

Data showing consumer prices rose more than expected in September initially sent the S&P 500 tumbling to its lowest point since November 2020 on Thursday, only for the index to soar around midday. In total, the index oscillated 5.4 percentage points on the day to close up 2.6%.

A key reason for the move, market participants said, was the unwinding of defensive positions that investors had put in place to protect their portfolios against further declines in equities ahead of the inflation data – which was a catalyst for sharp stock declines throughout the year.

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Chris Murphy, co-head of derivatives strategy at Susquehanna International Group, said many options traders who had bought defensive put options before the move were rushing to close them on Thursday, helping lift stocks.

“If you had coverage for this event and you start making money on it, you have to sell it to monetize or realize that money,” he said.

Despite Thursday’s big gain, Murphy said the big reversal could be a sign of more volatility to come.

However, “that doesn’t mean this rebound can’t last for a while,” he said.

Amy Wu Silverman, head of derivatives strategy at RBC Capital Markets, said investors had bought some $13 billion worth of notional call options, which profit when stocks rise, targeting the 3,600 level at 3,700 on the S&P 500. The index traded as low as 3,491 on Thursday. and closed at 3,669.

She warned that the effects of these options moves are “almost always” short-lived, with earnings season being one of the potential catalysts that could affect markets.

“As we head into reporting season, these dynamics can just as easily reverse as we get new fundamental information,” she said.

“Generally when you see these big intraday moves, it’s not a healthy sign for the markets,” said Garrett DeSimone, head of quantity at OptionMetrics. Moves are usually followed by reversals as traders look to hedge again, he said.

Others said that algorithmic trading may also have played a role in driving the markets higher.

“I think it was computer driven and now you see FOMO, the fear of missing a trade, catching up with what we saw on this rebound,” said Robert Pavlik, senior portfolio manager at Dakota Wealth.

A source at a blue-chip brokerage said there was no significant change in hedge fund long positions, with equity bets picking up. This indicates that Thursday’s rally tends to be short-lived.

To be sure, more of the move in US stocks has been down this year, with the S&P 500 (.SPX) seeing the most falls of at least 1% already this year since 2009, in its 23% of a year to year. declining dates.

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Indeed, despite the S&P 500’s frantic run on Thursday, the most recent inflation data does little to help the case for battered bull markets.

Traders now expect a fourth consecutive 75 basis point hike from the Fed at its November 1-2 meeting, while factoring in a roughly 14% chance the central bank will hike rates by 100 basis points. basis – bad news for stocks and bond markets which have been beaten by 300 basis points of gains already made this year.

Meanwhile, the turmoil in the UK bond market showed few signs of stabilizing, potentially forcing the Bank of England to provide more stimulus.

Warnings about potential market contagion and global financial instability have multiplied. Earlier this week, the International Monetary Fund flagged the risks of “disorderly repricing of assets” as global central banks tighten monetary policy.

Still, some investors looked beyond the short-term gloom, citing updated US equity valuations as one reason for cautious optimism.

The market will then focus on a pivotal third-quarter corporate earnings season to help support stock prices.

Meanwhile, as the November 8 U.S. midterm elections approach, one silver lining cited by investors is that the S&P 500 has been higher the year after each of the 19 midterm elections since World War II, according to Deutsche Bank.

“For investors with a long-term horizon (of at least three years), there are clearly bargains emerging in several sectors,” said Peter Tuz, president of Chase Investment Counsel.

However, “for investors focusing on the next six months, it’s probably difficult to see a stock market recovery or not.”

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Reporting by Lewis Krauskopf; Additional reporting by Ira Iosebashvili and Carolina Mandl; Editing by Ira Iosebashvili and Stephen Coates

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