Crash or Soar? Traders Are Preparing for Stock Market Extremes

Investors who just booked profits from one of the strongest first quarters for the S&P 500 Index in decades are preparing for what comes next — whether that’s stocks climbing higher or crashing back to earth.

With the stock market sitting at an all-time high as the second quarter begins, the tells for what traders are thinking lie in the options market. Demand for put options that pay off if there’s a minor correction is around the lowest in years. Meanwhile, traders are quietly picking up tail-risk hedges: instruments that do little if there’s a slight downdraft but offer protection if stocks swing wildly.

Taken together, it seems Wall Street isn’t particularly worried about a little slump. But there is growing concern that an unpriced risk could knock the bull market off its feet.

“There are a number of tail risks that you can point to, and the market has moved a lot, so I’m not surprised to see demand for tail hedges,” said Rocky Fishman, founder of derivatives analytical firm Asym 500. “I’m more surprised to see the lack of demand for basic hedges.”

As inflation continues to trend downward and the Federal Reserve signals its willingness to cut interest rates this year, rates volatility dropped to the lowest level since February 2022, creating a broadly favorable environment for stocks. The S&P 500 gained 10% in the first quarter — its strongest start to the year since 2019 — and posted 22 new all-time highs in the first three months of 2024.