Understanding Market Forces
As February 2025 comes to an end, market participants remain focused on the aftermath of the U.S. presidential election and its impact on financial markets. While headlines continue to shape investor sentiment, it is crucial to distinguish between noise and meaningful policy changes. This month's investment committee discussion centers around market stability, derivatives activity, and key areas of caution as we assess the evolving macroeconomic landscape.
Market Stability Post-Election
It is evident that post-election headlines continue to influence markets into February. Investors are closely monitoring policy shifts that could impact price action, yet it is equally noteworthy that the absence of aggressive decisions on major economic narratives has functioned as a stabilizing force. Despite three months of political and economic speculation, the S&P 500 has remained remarkably stable, not closing beyond +/- 3% of the 6,000 level since Election Day on November 5th. This reinforces the notion that market resilience is being driven by factors beyond just headline risks.
Derivatives Market and Volatility Dynamics
A key force behind this market stability is the persistent long gamma positioning by market-makers in the derivatives space. This phenomenon results in significant mandatory hedging flows into U.S. equities, exerting a mean-reverting influence throughout the trading day.
Additionally, on January 28th, zero-days-to-expiry (0DTE) options trading reached an all-time high, with 63% of S&P 500 options traded expiring the same day. To put this in perspective, this figure stood at approximately 40% in 2023 and only 10% in 2020. We believe this activity currently overshadows all other capital flows in U.S. equities, serving as a major volatility-dampening force. The hedging required for these trades further reinforces a mean-reverting effect, as market participants engage in systematic buying at intraday lows and selling at intraday highs, ultimately suppressing realized volatility.
Caution: Potential Unwind of ‘Trump Trades’
While we anticipate continued low realized volatility, our primary concern lies in the potential unwinding of popular “Trump trades” – assets that have surged on expectations of policy shifts under the new administration. Bitcoin, Tesla, and equities within tariff-sensitive sectors remain particularly vulnerable. Contrary to the broadly held belief that Trump is a bullish factor for markets, we are more skeptical. However, it is worth noting that equity indices may find a degree of support from the prospect of reduced scrutiny on China. A softer stance on trade could act as a stabilizing factor for mega-cap technology stocks, cushioning any potential downside pressure.
Conclusion
Overall, we expect a continuation of the current low-volatility regime, supported by derivatives market mechanics and the absence of extreme policy shifts. While the possibility of an unwind in speculative Trump trades warrants attention, broader market stability remains intact for now. As always, we will continue monitoring evolving risks and opportunities, ensuring a balanced approach to portfolio positioning in the months ahead.
Authors: John Couletsis and Kostas Metaxas