The stock market has been experiencing a lull since the end of 2023, setting the stage for a potential significant pullback. The coming expiration of options will likely bring about increased volatility and pressure for a stock market decline as economic data continues to support the view for fewer rate cuts than what the “market” has priced in.

Amidst this backdrop, the Federal Reserve has pushed back against the market’s anticipation of nearly seven rate cuts by the January 29 FOMC meeting in 2025. Recent data on jobs, CPI, and retail sales all point to the resilience of the labor market and retail sector, implying a less aggressive path for rate cuts.

January’s retail sales data surpassed estimates, exhibiting a month-over-month advance, while import prices remained resilient, defying expectations for a decline.

Indeed, the data seems to suggest a stickier inflation and a stronger-than-expected economy. The higher-for-longer policy path, coupled with a more elevated rate environment, is likely to curtail stock prices and lead to multiple contractions. The sudden and unexpected shift in the market’s trajectory in November was exacerbated by the Treasury Refunding Announcement, leading to a turbulent end-of-year rally. However, redemption seems to be on the horizon, with the possibility of the index returning to 4,100 over the next several weeks.

The coming period is expected to witness an expansion in volatility, particularly after the VIX options expiration on January 17 and the expiration of hedging flows for many mega-cap names on January 19. Accumulated put deltas in the VIX are likely to create a negative flow, potentially allowing the VIX to move back above 14.

This increasing volatility is further exemplified by positive flows in mega-cap technology stocks like NVIDIA Corporation (NVDA) and Meta Platforms, Inc. (META). The persistence of positive call deltas in these stocks has led to continuous upward momentum, supported by substantial hedging activities. These dynamics have contributed to a feedback loop that keeps the stocks bid higher.

The dynamics in option markets for stocks like Meta and Nvidia indicate a parallel situation. Open call positions at lower strike prices coupled with the stocks trading well above those levels have intensified the positive feedback loop, further propelling these stocks upwards. Such dynamics also hold for Microsoft Corporation (MSFT), where open call options are held at lower levels, bolstering its recent ascent.

While the S&P 500 index level remains relatively stable, the broader stock market is displaying signs of deterioration. The NYSE McClellan Oscillator has been on the decline, reflecting a deteriorating market breadth despite the apparent steadiness of the index.