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Micron Technology is up 150% since March 30. The Nasdaq is up 28.4% over the same time. The one-time leader of the AI rally, Nvidia, is bursting out to new all-time highs.
On the surface, these moves have the makings of another runaway rally. But I’m sensing a big disconnect – the rest of the stock market isn’t keeping up. A market carried by just a few stocks is in danger of imploding.
But few people seem worried about that possibility right now…
Volatility is low. And pullbacks have been rare. The S&P 500 (SPX) has barely had more than a couple of flat or down days since this rally began.
When markets become this complacent, trouble is never far away…
When volatility compresses like this, it can create a false sense of security. Risks to the downside feel contained… and folks start to assume that the status quo will continue.
That complacency is reflected in option premiums – especially put options, which help protect buyers from a fall.
It also means that market makers, who take the other side of an option trade, don’t need to hedge their positions aggressively. Low volatility, along with steady price action, means their exposure is easily manageable.
But that can all change in the blink of an eye…
It only takes one shock for things to unravel. Right now, we have tensions on the geopolitical front. We also face the risk of a macro surprise, such as a blowout inflation print that puts rate hikes in the cards.
Suddenly, everyone is scrambling to cover their positions.
But when everyone is on the wrong side of the trade, the reaction can cause a small move to morph into something much larger…
That’s why, from an options perspective, you need to be disciplined in your trade selections.
You don’t want to be selling options in a low volatility market. Even if you get the direction right, an explosion in volatility would mean buying your option back at a much higher price, leading to significant losses.
In short, you’re not getting paid adequately for the risk you’re taking on. Plus, closing the trade can be challenging as liquidity thins out.
The trick is to be patient and wait until conditions improve.
While the rally might seem orderly right now, you don’t want to be pulled into a costly trade. The bigger risk isn’t missing out on some upside. It’s being positioned the wrong way when the market inevitably resets.
That reset will come when folks least expect. It will be sharp, brutal, and unforgiving.
That’s when complacent traders will get torched, and the disciplined traders will come to the fore and make eye-watering profits.
Regards,
Larry Benedict
Editor, Trading With Larry Benedict
Reading Trading With Larry Benedict will allow you to take a look into the mind of one of the market’s greatest traders. You’ll be able to recognize and take advantage of trends in the market in no time.
