(Bloomberg) — Traders are eyeing this week’s U.S. inflation data for a possible break in the market calm.
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The options market is betting that the S&P 500 will move 0.9% in either direction after Wednesday’s consumer price report, based on the price of the straddles at the money of the day, according to Citigroup Inc. The report will be closely watched by traders for how much the Federal Reserve might cut interest rates this year.
A big change in the CPI report comes as volatility in the markets has been muted. The VIX index measuring the volatility of the S&P is near the lowest of the year, while the volatility of VIX options – used to hedge against a market sell-off – is the lowest in nine years. At the same time, since the Fed’s May 1 decision, bets in the Treasury market have been leaning toward more aggressive rate cuts.
The market as a whole is preparing for a significant change in the CPI, in line with expectations on May 23, the day after Nvidia Corp. published. of its latest financial results. These implied moves are larger than expected after the government’s next jobs report, due June 7, even after employers cut hiring in April, suggesting a cooling of the labor market after a strong start of year.
“Inflation has been the most important event for traders over the last couple of years and still is,” Stuart Kaiser, head of U.S. equity trading strategy at Citigroup Inc., said by telephone. “Despite a recent drop in wages, with all numbers showing more than 150,000 jobs created in any given month, investors will be largely comfortable with this as it still reflects a strong labor market. If job growth were to be lower than this figure, the market would begin to focus more on hiring growth rather than inflation.
Overall, lower volatility and lower premiums for puts have made broader stock market hedging more attractive, and VIX call spread buying was seen last week.
“The rising interest rates that have driven SPX futures higher are increasing call premiums over sales,” Tanvir Sandhu, chief global derivatives strategist at Bloomberg Intelligence. “This has facilitated the entry of collar strategies that sell calls and buy puts. The falling SPX bias, which is near the low of the last 10-year range, has also reduced the cost of this strategy.
The Treasury market positioning behind the inflation report appears to have been somewhat neutralized, given the short covering and initiation of new long positions seen since the announcement of the Fed policy and the April jobs report.
Immediately following the central bank’s decision, notable short covering of SOFR futures was seen as Fed Chairman Jerome Powell appeared to eliminate the tail risk that a hike would be the next policy action. Long positions then began to build. Recent options suggest that tail risk hedging has shifted toward a more aggressive rate cut path, with some positioning in SOFR options even focused on the possibility of a rate cut as soon as July.
A major risk-reversal trade late last week in options expiring May 24 targeted a drop in the 10-year Treasury yield to 4.25%, while risking losses of up to $15 million. , an increase to approximately 4.7%.
Read more: High-risk options bet on bond rally at risk of losing millions
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