Over the past week, the market has started to absorb housing data that is  looking increasingly poor. Data on both the number of housing transactions per household and the ratio of sellers vs. buyers suggest that the current housing market is approaching levels seen during  the Great Financial Crisis. This can be seen in the National Association of Home Builders Market Index (in white). This index has reached the lows last seen in late 2022 and continues to decline, even during the most crucial time of the year for the housing market. Housing leads the economy in and out of recession, given the large multiplier effect. Traders see this most clearly by looking at new orders data, which follows the housing market. This data looked promising at the start of the year, but it now appears to have been front-loaded in anticipation of tariffs. Market watchers might expect new orders to move lower in conjunction with housing data. The last two pieces of the puzzle are earnings and employment. When companies see orders rise, profits will rise, and eventually they will hire more workers. The opposite is true. As the order book stalls or falls, earnings will eventually be hit and workers will be laid off. The equity market is strong on the back of good earnings and employment that remains strong. Can this continue? The H.O.P.E moniker illustrates how money flows through the economy, and it currently indicates a slowdown.

Falling new orders are a good indicator of the economy’s future direction, but I find that the ratio of new orders to inventories provides an even clearer picture. Companies typically draw down their inventories before placing new orders, which influences the headline PMI. The ratio (in orange) has been falling all year long. This indicates that the PMI might also continue to decline as it tends to move in tandem with the stock market. The economy leads to earnings and earnings drive stock prices. However, there is currently a disconnect between equity prices and the economy. While year-over-year changes in equity prices suggest that the economy is in good shape, the economic data is raising doubts about this. Can stocks withstand weakening economic data at a time when the Fed says it’s on pause?

I have long believed that bitcoin serves as a barometer for the market’s risk appetite. This was even before the institutionalization of bitcoin via ETFs. After a trip to Europe the past two weeks, I am even more convinced. Speaking with investors in Germany, Switzerland, France and Austria, the topic of crypto was top of mind. European investors generally have a less robust equity culture compared to their U.S. counterparts, partly due to the shallower pool of equities and start-ups in Europe, and partly because they tend to be more risk-averse. However, European investors are willing to take risks in the crypto market, with Millennials trading crypto on their phone much like they trade meme stocks via apps in the U.S. European investors view the crypto market as disruptive technology, similar to how start-ups are seen in the U.S.

Thus, I note that despite the recent positive news in crypto, such as advancing stablecoin regulation and a bitcoin conference featuring  politicians, if markets fail to rise on these positive catalysts, it may be a sign that they are fully priced. With bitcoin rolling over, I am not surprised to see E-mini S&P 500 futures struggling. Bitcoin definitely led markets higher from the lows. Is this a sign markets may see a downside?

While the trend on the E-mini S&P 500 futures chart looks like it might be starting to move higher after an amazing bounce from the lows, there are a few worrying signs on the technical charts. The first is the MACD in the middle panel, where the moving averages are crossing over and beginning to head lower. While this doesn’t necessarily mean a sharp downturn, it certainly suggests a market that may be about to stall. The other worrying sign is the negative divergence between price and RSI. As the E-mini S&P 500 hit new highs last week, the RSI did not hit the same new highs, in a negative divergence that points to downside risk. The Ichimoku Cloud support comes in around 5500, but that is a potentially tradable move. There is support around 5850, a previous support level that then became resistance. If this doesn’t hold, there could be downside risk.

E-mini S&P 500 options exhibit a downward sloping nature, which is not entirely surprising given implied volatility levels are still above average. In a sense, traders are suggesting that there could be mean reversion with a term structure shaped as such. One noteworthy item is that Monday options (series ending AM5) are consistently the lowest implied volatility of the week. This is not surprising, as Monday options historically are priced at a discount given there is a quiet weekend ahead of expiration. However, with the potential for geopolitical risk over a weekend, riots in Europe this past weekend and U.S. tariff news that can come out at any time, buyers of volatility may be able to use this discount to their advantage. In some ways, it is not surprising to see the E3AM5 contract trade lower because it expires before the FOMC meeting. However, the Fed has been more likely to leak information into the market before meetings to avoid surprises, so perhaps significant moves will happen beforehand.

The bottom chart shows the implied volatility skew across all expirations. While there is a consistent bid for downside puts over upside calls, something almost always present in equity markets, the skew tends to be a bit flatter (closer to four vol points) near the front part of the curve than the six vol points (more the norm) as things move further out on the curve. In fact, the E3AM5 expiration has 25 delta skew that is around that for vol point level.

Putting this all together, I aim to find a trade for the E3AM5 expiration, because the implied volatility for that date looks suppressed relative to other dates. While I know Monday’s can typically embed less news flow, my sense is weekends have gotten more volatile than normal given the current geopolitical landscape. While the market has begun to fade with tariff news, my recent trip to Europe tells me tariffs are still very much top of mind for European investors, many of whom are still overweight U.S. stocks and potentially looking for a reason to reallocate back to the home markets. In addition, tensions are rising in Europe and the Middle East, which potentially make weekends more volatile. While the expiration is before the next FOMC meeting, I’m counting on the Fed to let any decisions leak into the market, as it has been prone to do lately.

I pointed out that the skew is flatter than normal in these expirations, and a skew trade presents a nice way to fade the market. It gives a trader some room to the upside before they need to cover their shorts, and it also provides leverage to a downside move. They can profit not only from the directional call but also from any increase in implied volatility if the marker moves lower. I chose to buy the 5800 put, which is below the support line on the chart. I’m able to fund that by selling a 5950 call. The implied volatility differential between these strikes is less than three volatility points,which is lower than normal.

If futures stay between 5800 and 5950 over the next two weeks, with the MACD indicating more of a flat-lining market than a market in correction, I will still make money because I took in a small amount of premium to do the trade. The risk to the trade is a move above 5950 to the old highs. I would bear this same risk if I went short futures, so a trader needs to decide where they would set their stop loss in the event of that move. On the downside, the trader benefits from leverage due to delta and gamma. Any increase  in implied volatility provides an additional opportunity for the trader to profit from selling their option, not just by covering deltas. This gives them two ways to earn on a move lower.

When the market prices as if everything is in a ‘normal’ state, but traders may not actually be in a normal market, there can be opportunities to capitalize on the discrepancy. I believe the pricing of the Monday options presents such an opportunity in the current geopolitical landscape. With daily expirations in E-mini S&P 500 options, traders can look to take advantage of such pricing.

Good luck trading!

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