The rally since early-April lows has equity bulls aggressively expressing their sentiment in options, which, should the current trajectory persist, will have potentially reached a dangerous level soon.

Optimism is in the air. Equity longs are expressing this in the options market, aggressively so in the most recent sessions.

In three of the five sessions last week, the CBOE equity-only put-to-call ratio registered readings of sub-0.50, with Wednesday’s 0.412 the lowest since July 2023. The 21-day average finished Friday at 0.52, which is low enough to begin unwinding; that said, several times in the past, the average has continued lower toward the high-0.40s before sentiment goes the other way (Chart 1).

Optimism has paid off for the bulls – big time. Since 7 April when the S&P 500 bottomed at 4835, it has rallied 23.2 percent to 5958. Prior to this, from the all-time high of 6147 posted on 19 February, the large cap index quickly gave back 21.3 percent.

At the April low, bulls defended dual support, made up of a rising trendline from March 2020 and horizontal support going back to December 2021-January 2022 at 4800 (Chart 2). The move since the April low has been fierce – up in 16 of the last 19 sessions.

The index is now 3.2 percent from the February record, which probably acts as a magnet in the sessions to come. Momentum is strong, with the daily RSI (69.76) just under 70 and the weekly at 56.93; if, however, the weekly stalls around here, that would represent persistent lower highs in this metric since last July, and that would be a yellow flag.

Small-caps already are a little tentative. Last week, the Russell 2000 rallied 4.5 percent to 2113; 2100 has proven to be an important level going back to January 2021 (Chart 3). Most recently, the level was breached nearly two and a half months ago, in early March. Kudos to the bulls for having recaptured it, but the fact remains that the index has only managed to edge past the support-turned-resistance and have used up a lot of buying power doing so.

From 25 November last year when a new all-time high of 2466 edged past the prior high of 2459 from November 2021 through the April 9^th low this year of 1733, the Russell 2000 tumbled 29.7 percent. For nearly two years through December 2023, the index was rangebound between 1700 and 1900 before breaking out. After defending 1700 early last month, bulls then rallied the index 21.9 percent, which is subdued versus what the large-caps have produced.

Small-cap bulls’ real test lies ahead. Just above lies trendline resistance from last November’s high. In the event this hurdle gets taken out, they have a shot at 2170s-2200.

Speaking of which Nasdaq 100 bulls are now probably eyeing the February 19^th all-time high of 22223, which is 3.7 percent away from last Friday’s close of 21428 (Chart 4). The index has already added 29.5 percent from the April 7^th trough of 16542. Earlier, from the February high to last month’s low, it tumbled 25.6 percent.

Momentum is strong, with the daily RSI (71.67) having just entered the 70s; that said, this is also a sign that things have already heated up. A reversal is always possible in these circumstances. But for now, unless something comes out of left field, the path of least resistance is toward the February high.

For this to happen, volatility needs to cooperate, and it just might in the sessions ahead.

VIX has had quite a spike reversal since printing 60.13 on 7 April (Chart 5). The volatility index is now down for six consecutive weeks, ending last week at 17.24. The April high was rejected at a falling trendline from March 2020 when VIX peaked at 85.47, which was the second highest print ever after a record 89.53 was hit in October 2008.

Momentum remains down for VIX. Crucially, just underneath lies trendline support from last July when the index hit 10.62 and reversed higher. This support lies around 16.

Should VIX head toward 16, this would open the door for the ratio of VIX to VXV to go deeper into oversold territory.

VIX measures market’s expectation of 30-day volatility on the S&P 500. VXV does the same, except it goes out to three months. During a risk-on investing environment, as has been the case in recent weeks, demand for VIX-derived securities is lower than VXV. The opposite is true when sentiment turns to risk-off.

Last Friday, the ratio closed at 0.859. Earlier, in and around the time the S&P 500 bottomed early last month, VIX:VXV stayed north of one for three weeks in a row, setting the stage for the kind of rally the S&P 500 has experienced.

As things stand, the ratio has room to go lower still, before it goes deeper into the red zone. In the past, this has happened when the ratio reaches high-0.70s to low-0.80s (Chart 6). When that happens, it will be time for shorts to get active.

Thanks for reading!

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