The price of deeper out-of-the-money insurance in equities is falling, implying lower demand for
crash insurance. This suggests the market believes the Fed put is getting closer.

A conundrum all year has the been the relatively low level of the VIX despite equity markets being in a bear market. The VIX has been low relative to implied volatility, relative to longer-term volatility, and remains low compared to cross-asset volatility. Most notably, though, the VIX has been low -- and
continues to fall -- versus at-the-money volatility.
 
This is due to the price of further out-of-the-money put options falling by more than options that are less out of the money. We can see this by looking the difference in volatility between 80% and 90% out-of-the­-money put options and see it has been falling.

As the VIX is a weighted average of all S&P options with approximately 1-month to expiry and that have a non-zero bid, the lower price of these deeper out-of-the-money options is keeping the VIX lower relative to at-the-money volatility than it otherwise would be.

Puts have still been in demand though. The put/call volume ratio has been rising, showing that investors are buying more puts relative to calls. But the put/call price ratio has been falling, showing that investors have been paying relatively less for those puts.

Investors have therefore not been paying up as much for crash insurance, and buying puts that are less out of the money. The Fed is now well into its hiking cycle, and the market is inferring it believes the Fed put is getting nearer.

Certainly, current oversold conditions suggest a short-term bounce is at hand. But while excess liquidity remains depressed, it will be hard for the market to make new highs. The Fed put may be closer, but that does not mean the bear market is over.

Eoin Treacy's view

No two crises are the same and yet the temptation to think “this time is different” has been proved wrong on so many occasions that the term is a cautionary tale. The Bank of England intervened to support the domestic pension system this week. Several schemes required £100 million in additional capital each and others were looking at closing. The central bank had no choice but to wade in and provide some stability. The ramifications of this move raise more questions than answers.

In the USA, we hear the private equity sector has $3.2 trillion in dry powder, consumers haven’t even begun to spend down their pandemic savings, unemployment is low because companies are afraid to fire lest they have difficulty finding new workers when the market recovers, and inflation may already be peaking with housing and used car prices rolling over.  

This suggests, to me at least, liquidity is not nearly tight enough to contain inflationary pressures. It has been clear the Federal Reserve will continue to raise rates until something breaks. Nevertheless, investors continue to expect the Fed to blink at each successive meeting. Another way of saying that is, a crash is imminent. That would force the Fed to change course. 

The UK pension system broke and necessitated intervention. That is not going to change the trajectory of Fed policy. The options pricing discussed in the above article reflects the continued willingness to buy the dip. However, inflationary pressures will not have been snuffed out until that enthusiasm is disappointed. The only real question is how big of a negative event will be required to scare them.