Citadel says equity risk-reward outlook worsens

It’s no secret that September is the worst month for the stock market, with the S&P 500 having the lowest average monthly return. Add to this the fact that option prices are at their lowest all year, and the risk/reward of buying protection in the stock market looks compelling.

Scott Rabner, head of equity and equity derivatives strategy at Citadel Securities, said in a letter to clients on Monday that he believes the bullish setup that drove the S&P to all-time highs in August is changing.

“This is not a long-term constructive change in our view of the stock; it is a short-term risk/reward shift,” Rabner said in a strategic report, citing the earnings calendar, buyback prospects, seasonality and retail trading patterns as reasons for caution.

“Collectively, they end up changing short-term asymmetries,” Rabner said. “The upside factors are becoming less prominent, just as the downside factors are becoming more numerous.”

of S&P500 It rose almost 7% from late July to the first week of August, hitting an all-time intraday high of 7,816.70 this month. Since then, the benchmark gauge has fluctuated sideways and declined as volatility has been measured. CBOE Volatility Index (VIX) Last week it fell to 14.1, the lowest it has been all year.

According to Cboe data, individual stock volatility, which was at a record high relative to index volume, has also declined, citing the spread of the exchange’s VIXEQ index, which measures the implied volatility of the top 50 stocks in the S&P 500. Similarly, the spread between Nasdaq 100 volume and SPY, as measured by Invesco Trust QQQ, has fallen from an all-time high in June to the lowest 20th percentile in a year, according to Cboe.

“Better-than-expected earnings from tech companies (as seen last week with NVDA) helped compress the volatility risk premium for tech stocks as concerns about AI trading receded,” Mandy Hsu, head of derivatives market intelligence at Cboe, said in a note Monday morning.

As a result, downside protection is cheaper, Citadel’s Rabner said.

Rabner said September was not just a rough month from a historical perspective. It was also the weakest month of the year for retail trader purchasing activity, which is tracked by Citadel. Since 2019, the average retail net buy amount on days when the S&P falls is about half the average.

LaVerner also wrote that corporate share buybacks will slow down as the period during which companies are prohibited from doing so will accelerate from around September 12th.

“Investors are entering a period with more macro events, even though they are paying relatively little premium,” Rabner said.