Eurostoxx futures have risen by 0.4% in early European trading, suggesting an optimistic outlook as European stocks aim to end the week on a higher note. German DAX futures have increased by 0.5%, French CAC 40 futures by 0.4%, and UK FTSE futures by 0.3%.
This positive momentum comes after a strong performance on Wall Street the previous day, with US futures also continuing to rise. Tech shares are contributing to the upward trend, with S&P 500 futures currently showing a 0.2% increase.
Opportunity To Sell Volatility
We see the current positive futures as an opportunity to sell volatility, but with caution. The market’s upward momentum suggests traders can collect premiums by selling out-of-the-money put options on indices like the S&P 500. This strategy profits if the market continues to climb or even just stays stable.
The rally is underpinned by solid data, especially from the United States. The latest Consumer Price Index report showed inflation cooled to 3.3% in May, supporting the case for an economic soft landing. This data encourages risk-taking and fuels the tech-led advance we are currently witnessing.
However, we must listen carefully to central bankers like Powell. The Federal Reserve has signaled it now expects only one interest rate cut in 2024, a more cautious stance than the market had hoped for. This suggests the path higher might not be smooth, and any unexpected inflation data could cause a rapid reversal.
In Europe, the situation is slightly different, creating a potential divergence. While the European Central Bank did cut rates recently, Lagarde has been wary of promising more due to Eurozone inflation ticking up to 2.6%. Therefore, we view upside in indices like the DAX and CAC 40 as being more fragile than in their US counterparts.
Volatility Levels
Volatility levels confirm this calm but fragile environment. The VIX index has been trading near 13, a historically low level that signals market complacency and makes selling options attractive. History shows, however, that prolonged periods of low volatility can end with sharp, unexpected spikes, making cheap, long-dated protective puts a prudent portfolio hedge.
Given these factors, we advocate for a two-pronged approach in the coming weeks. Traders should look to benefit from the current uptrend by using strategies like bull put spreads, which cap risk. Simultaneously, they should allocate a small portion of their portfolio to buying longer-term downside protection in case central bank policy or economic data surprises the market.
