Stocks are rallying so quickly that Wall Street is seeing a rare S&P 500 (SPY) and Nasdaq-100 (QQQ) volatility setup that has only appeared four times in the past decade, according to Goldman Sachs (GS). Even as the S&P 500 has gained about 7% since mid-April and indexes keep pushing toward records, implied volatility has not fallen much. The VIX has stayed little changed since moving below 18, which suggests that traders are still paying up for options even as stocks rise. That unusual setup appears to be driven by two forces happening at the same time.
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On the one hand, traders are aggressively buying call options on high-flying stocks, especially in popular areas like technology and semiconductors. On the other hand, some investors are still hedging the overall market because they see the VIX as relatively cheap compared with the implied volatility in those hotter sectors. As a result, the correlation between the Nasdaq-100 and the price of its one-month call option has turned positive for only the fourth time in the past decade. Goldman’s Brian Garrett described the move as an “up crash,” writing that equity markets have “crashed higher” over the past month.
While some traders think that this kind of rally could set up a sharp reversal, Garrett said that the historical data does not support that view. Goldman found that when this relationship turns positive, stocks have averaged a 2.7% return over the next month, above the 1.5% average one-month return over the period studied. Still, there is one warning: the current correlation is the highest since January 2017, and while 2017 was an extremely calm and bullish year, the following quarter brought “Volmageddon,” when the VIX spiked to 50, and short-volatility ETFs collapsed.
Is SPY Stock a Good Buy?
Turning to Wall Street, analysts have a Strong Buy consensus rating on SPY stock based on 416 Buys, 79 Holds, and eight Sells assigned in the past three months, as indicated by the graphic below. Furthermore, the average SPY price target of $853.18 per share implies 14% upside potential.
