Options Quarterly Commentary Q1 2025

The US equity market experienced significant turbulence in the first quarter of 2025. Initially, investor optimism surrounding the new administration fueled a strong start to the year, reinforcing the narrative of US exceptionalism. However, this momentum was short- lived due to concerns around the future of the AI landscape following the emergence of Chinese AI company DeepSeek in late January, and US tariff policy uncertainties which dampened investor sentiment and growth expectations. Trump imposed aggressive tariffs on Canada, Mexico and China in February, and March brought further concerns with additional tariffs implemented on autos, steel and aluminum. Trump’s declaration of ‘’Liberation Day’’ on April 2^nd to introduce reciprocal tariffs, escalated global tensions and heightened investor uncertainty. Consequently, the S&P entered a correction phase in the latter part of Q1, declining 10% from its all-time high. During the March FOMC meeting, the Federal Reserve maintained its stance of not rushing to cut interest rates, despite the potential inflationary impact from imposed tariffs. US equities posted their worst quarter since Q3 2023, with mega-cap technology stocks leading the downtrend falling by nearly 15%. The S&P 500 Index SPX ultimately closed at 5611.85 (-4.58% vs Q4 2024).

As we entered the latter half of Q1, constantly evolving tariff policies caused equity implied volatility to jump as the options market priced in outsized swings, with the VIX hitting an intra-day high of 29.57 on March 11^th. According to JP Morgan, by quarter end, the options market had projected a 1.6% move in the S&P in either direction as a response to Trump’s April 2^nd tariff announcement. They also noted that SPX volatility term structure became inverted towards quarter-end meaning that implied volatility was higher for shorter term expirations than longer term expirations. The CBOE S&P 500 Volatility Index VIX closed Q1 at 22.28 (+28.41% vs Q4 2024).

Source: Bloomberg

According to Nomura, investor fears became increasingly evident due to an increased demand for downside protection which led to a steepening of SPX skew and minimal concern about the ‘’right tail’’ upside, with SPX call skews dropping to the 6th percentile (shown below). They also noted that this trend was not limited to indices but also applied to single stocks, particularly ‘’Magnificent 7’’ names which saw a similar volatility skew. Due to the surge in hedging demand, options dealers remained short gamma, and to stay delta hedged, were forced to sell during declines and buy during rallies, further exacerbating market volatility.

Source: Nomura

The NTSI options desk observed an uptick in hedging activity, alongside a decrease in upside speculation as we progressed through Q1. Some clients chose to monetize existing hedges whilst implied volatility was elevated. Additionally, we saw clients utilize out of the money VIX calls as a tail hedge against potential market sell-offs. This was a notable trend in Q1, with February 28th marking the second highest volume day on record for buying deep out of the money ($50+) VIX calls, with volumes reaching 250,000 contracts, the largest one-day total since May 4^th, 2023 (CBOE).

Market turbulence throughout the quarter significantly boosted demand for zero-day-to-expiry (0DTE) options. In the first two weeks of March, 0DTE trading volumes surged, with average daily volume for SPY and SPX increasing by 73% and 43% from February. This totaled a combined notional exposure of over $1.5 trillion per day, primarily consisting of largely out of the money strikes (Bloomberg). This sharp rise in 0DTE options can be attributed to market volatility driven by rapidly changing tariff policies which led investors to use short- term options that avoid overnight risk. March SPX 0TDE options accounted for 56% of total SPX options volumes (CBOE).

Source: Bloomberg

As we move into Q2, we’ve already observed a substantial market correction and outsized intra-day swings following Trump’s April 2^ndtariff announcement and ensuing trade wars. This level of extreme volatility is expected to persist, with Trump showing little willingness to back down on tariff policies and countries such as China quickly retaliating. Additionally, we are beginning to see the potential impact these tariffs could have on future economic growth and inflation, sparking recession fears.

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