The S&P 500’s biggest plunge since 2020 has now been followed by its biggest rally. Hedge-fund and short-seller stocks are sailing around at extreme speed. Banks, slammed when war broke out, are suddenly surging as traders pile into bullish options.

Investors have a multitude of worries when it comes to Ukraine, the economy, central banks, and the pandemic. Making everything harder has been an easy-to-scare market that has gotten a lot jumpier at the surface.

While nobody’s saying anything’s broken, small moves are quickly becoming large ones thanks not only to geopolitical stakes but also a host of structural forces that often stir alongside big macro threats.

Measures of market liquidity in index futures began the month as weak as they’ve been in years. Options dealers sitting on giant positions are working furiously to keep books balanced by buying and selling shares. Hedge funds are pulling out while day traders dive in, spurring dizzying swings in the S&P 500. In its latest twist, the gauge surged 2.6 per cent Wednesday, paring a 4.9 per cent drop over the previous four sessions.

“Unwinding of hedges is definitely contributing to the upside move,” said Chris Murphy, co-head of derivatives strategy at Susquehanna International Group. “Given how much investors have been reducing their positions so far this year, I’d think some real money that wants to buy the dip is contributing as well.”

Jarring reversals have been a market constant in 2022 as traders struggle to get a grip on the path of economic growth with lingering uncertainty around monetary policy following Russia’s invasion of Ukraine.

Accompanying the turmoil is thin liquidity that made it harder for traders to buy and sell securities without having an outsize impact on prices. Both a cause and effect of heightened volatility, a lack of liquidity was an issue flagged by Goldman Sachs Group Inc. strategists at the end of February. As measured by orders from market makers ready to transact on American exchanges, it had slumped to levels seen only three times in the last 15 years, Goldman’s data on S&P 500 E-mini futures order book data showed.

Volatility has hardly been confined to equities. Market structure constraints also contributed to wild swings for a number of commodities, most notably oil and nickel. Wednesday’s equity rally was at least partly the result of a tumble in crude, a commodity whose surge following Russia’s invasion of Ukraine stoked fears of an economic recession.

Helping exacerbate moves are also options dealers, who have been in a “short gamma” or “short delta” position where they’d need to buy stocks when they go up and sell when they fall to keep a neutral exposure. As the end of Tuesday, their delta exposure for S&P 500 products sat in the bottom 0.2 percentile of a historic range, while that for Nasdaq was the lowest since at least 2014, according to estimates by Charlie McElligott, a cross-asset strategist at Nomura Holdings.

“Any rally would have potent kindling for a short-squeeze from said ‘negative Delta,‘” McElligott wrote in a note.

As oil pulled back and hopes for a ceasefire in Europe surfaced, traders rushed to economically sensitive companies. Financial shares, hit hardest during Ukraine war, jumped almost 4 per cent.

Meanwhile, there were hints that hedge funds were embracing equities. As stocks bounced back, a Goldman Sachs basket of hedge funds’ most-favoured stocks climbed 4.4 per cent, a sign of buying impetus. A similar index tracking the industry’s most-hated stocks also outperformed the market, the upward squeeze created when fast-money traders are forced to close out positions.

“A lot of investors have massively leveraged their portfolios which led to potential seller exhaustion,” said Alon Rosin, Oppenheimer & Co.’s head of institutional equity derivatives. “And now the market is trying to induce FOMO while doing a good job of squeezing the shorts a bit here.”

Bloomberg