S&P 500: Higher Rates, Surging Oil, and a Stronger Dollar Threaten Equities

Stocks ended the session little changed, rising just 4 basis points. As anticipated in this free daily note, the S&P 500 opened with a gap lower and quickly tested the 6,800 put wall. Implied volatility was sharply compressed as those put positions were likely unwound, paving the way for a rebound in equities.

In short, the action unfolded largely in line with Sunday’s outlook.

The more notable development was that the CBOE Volatility Index still climbed to 21.5 on the session after spiking to roughly 25 earlier in the day. Examining the volatility smile, implied volatility for the SPDR S&P 500 ETF Trust March 20 options moved broadly higher. With minimal net price change in the underlying, the bulk of the adjustment reflected a parallel upward shift in implied volatility across the curve. Put skew steepened, while call skew flattened.

In other words, volatility did increase overall, but the sharp pullback from intraday highs helped power the rebound following the opening gap lower.

At the same time, the gap between the S&P 500 Dispersion Index and three-month implied correlation tightened. Historically, that spread has tended to act as a leading indicator for the S&P 500. It’s hard to envision a setup where implied volatility stays elevated and correlations continue to climb without the index eventually facing downside pressure.

For the moment, though, options traders seem comfortable maintaining positioning around the 6,800 level.

Equities could also face headwinds if interest rates and crude prices keep pushing higher. A combination of rising yields and elevated oil costs is rarely constructive for economic growth. The same dynamic extends to the U.S. dollar — since 2022, oil, rates, and the greenback have often moved in tandem.

If all three continue advancing, financial conditions would likely tighten over time, a backdrop that historically has not been favorable for stocks.

But as long as the options market keeps propping up the S&P 500, what could possibly derail the rally?

Sources: Michael Kramer