Image Source: Dimitri Karastelev on Unsplash
The coming week will easily be one of the busiest times of the quarter, if not the year. Wednesday, April 29, will be the highlight, driven by a Fed meeting and earnings from Meta, Microsoft, Amazon, and Alphabet later that afternoon. Then on Thursday, there will be ECB and BOE rate decisions, along with Apple results after the close. Let’s not forget the BOJ rate decision on the evening of April 27, Eastern Time.
That is a lot of information for the market to absorb in a short period of time. On top of that, headlines out of Iran continue to flow into the trading week, whipsawing everything from oil to stocks, as well as rates and the dollar.
As noted in the free weekend update, the dispersion index is at an extreme, and its seasonal cycle is due to turn lower. Once the mega-caps report this week, their implied volatility levels should begin to fall and move more in line with index-level volatility. That will push dispersion lower and implied correlations higher.
It doesn’t matter whether companies report good or bad results—the dispersion trade is likely to unwind, and implied correlations should rise. This is driven by mechanics, not fundamentals. No chart or headline will warn you in advance.
Implied volatility typically rises into earnings and then falls afterward, which is why the gap between S&P 500 constituent volatility and index-level volatility is so wide. That spread is now at a historically elevated level, which is why the dispersion index is at such a high level.
A good example of this is Meta. If its one-week at-the-money implied volatility falls back to its historical range, it could decline from roughly 65% to about 23%-28%. That would cause options premiums for May 1 expirations—especially out-of-the-money contracts—to fall sharply.
Image Source: LSEG
A $700 call expiring on May 1, currently trading for around $15, would require the stock to rise above $715 just to break even. The issue is that the option is carrying an implied volatility of about 75%.
If implied volatility falls as expected—by roughly 50% to 55%—IV would drop to around 30%, and the premium could collapse to roughly $3.50.
Meanwhile, Meta is pricing in about a 6.3% post-earnings move. From Friday’s close, that implies a range of roughly $630 to $715. In other words, the stock would need to exceed the implied move for that $700 call to make money.
Image Source: LSEG
There is another issue: significant call gamma is concentrated at $700, making it a likely resistance level. In a positive gamma environment, dealer hedging flows typically involve buying on pullbacks and selling into rallies.
If the stock cannot clear $700, many options positioned at or above that level are likely to expire worthless.
Image Source: Mott Capital
That also means call holders are likely to become sellers, creating additional pressure after hours and into Thursday and Friday. Now apply that setup across the other mega-cap names, and it becomes clear why dispersion is likely to fall and implied correlations are set to rise. The unwind of this trade is likely close.
That said, if Meta delivers strong enough results to break through the $700 mark, the rally could extend somewhat longer. But the mechanics do not favor that outcome. I always find it interesting to hear there’s “no value” in my work. The market will decide that soon enough.
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