The stock market is experiencing a turbulent summer rally that is difficult to spot on the surface: the S&P 500 has hit new record highs, while the CBOE Volatility Index (VIX) is hovering near its year-to-date lows. The volatility of small-cap stocks relative to large-cap stocks has fallen to its lowest level in at least a year.

This calm masks a turbulent process beneath: individual stocks have experienced sharp swings, with the volatility spread between the S&P 500 and the Nasdaq 100 reaching a record level. The semiconductor sector once corrected by 25%, prompting a massive influx of traders buying put options, with trading volumes for the VanEck Semiconductor ETF (SMH) reaching an all-time high. Despite the sharp sell-off in the previously soaring memory chip sector, the VIX has remained well below its lows from the first quarter, and the sell-off in the S&P 500 was merely a brief, impulsive correction.

As the market stabilised and broke higher in August, the extreme positioning completely flipped to the other side: the Nasdaq options market saw one of the strongest bullish trading days in a decade, with CBOE call option volumes hitting a new record. A report released by the CBOE on Monday showed that, across options with maturities ranging from one month to one year, the current bullish sentiment for S&P 500 call options relative to put options is the strongest in at least a year. Data indicates that the put/call ratio for options expiring next month with a 25% delta—options that have a 25% probability of being in the money at expiration—has fallen to its lowest level since mid-2024.

"The speed of the rally following the earnings season over the past few weeks has exceeded market expectations," Mandy Xu, Head of Global Market Derivatives Intelligence at CME Group, said in an interview. "The market is clearly experiencing a short squeeze, which is why there is such strong demand for bullish calls."

However, one key signal worth noting is that traders are also heavily holding deep out-of-the-money put options to guard against a sudden market crash. CME data shows that the ratio of 10-delta put options (with approximately a 10% probability of expiring in the money) to 25-delta put options is at the 66th percentile of the past five years, indicating unusually high demand for these low-probability, black-swan hedging options. This is the stock market's version of "trust but verify"—using low-cost put options to build a crash protection shield.

"Standard portfolio hedges have been unwound, but the extreme tail-risk insurance positions, designed to protect against a sharp decline, remain elevated," Xu said. "If you're looking for evidence of market fear about a rapid downturn, the focus should be on tail-risk hedging."

Data also shows that many traders are viewing small-cap stocks as a volatility hedge. The Russell 2000 index has gained 20% year-to-date, outperforming the S&P 500 and the Nasdaq 100. According to CME data, the Russell 2000's volatility saw the largest decline among major broad-based indices last week, falling below 17, a level in the 2nd percentile of the past five years.