Fearing a pullback and also fearing to miss out, Wall Street has started using this "advanced strategy" to hedge risks

Against the backdrop of record highs in the U.S. stock market, Wall Street investors are turning to more complex over-the-counter (OTC) options tools to manage risk.

In the face of spreading market complacency and the resurgence of meme stocks, Wall Street strategists are beginning to discuss protective trades against pullbacks from highs. Analysts recommend exotic options products such as Lookback Put Options and Re-settable Put Options to address the issue of traditional options quickly becoming ineffective in a rising market.

Traditional Hedging Strategies Face Challenges in a Bull Market

In a continuously rising market, traditional options hedging strategies face challenges.

Standard put options quickly become out-of-the-money as indices rise, forcing investors to constantly adjust positions to maintain the desired level of downside protection.

UBS strategist Kieran Diamond stated that historical data shows that high markets are more likely to continue rising rather than reversing, which increases the likelihood of traditional put options becoming deeper out-of-the-money (protection failure).

OTC options products like Lookback Put Options do not face similar issues.

According to the rules, the exercise price of Lookback Put Options is set based on the highest market price during the option's validity period, allowing investors to "look back" at historical highs to determine the exercise price. This means that even if the market continues to rise, the exercise price of the option will be adjusted upwards, thereby increasing the option's effectiveness.

The value of lookback options is a function of implied volatility, which is currently very low. The ongoing rise of the S&P 500 has pushed most implied volatility and realized volatility indicators to their lowest levels in months.

The extremely low volatility indicators make Lookback Put Options more attractive, as investors can obtain higher risk protection at a relatively low cost compared to standard options.

UBS statistics show that in the past 10 years, when the market was at a high, if the exercise price of Lookback Options was set at 95% of the spot price (i.e., 95% of the current market price), the exercise price of Lookback Options would be adjusted upwards by 3.4% during the option's validity period based on market fluctuations.

In other words, if the market price rises, the exercise price of Lookback Options will be adjusted upwards (providing protection), while the additional cost incurred by investors is only 0.4% more than that of traditional options.

Tech Stocks Become Hot Targets

Analysts say that the best use case for Lookback Put Options is when the market rises first and then crashes. In this scenario, the additional returns compared to traditional options can be quite substantial.

Pete Clarke, UBS's global head of volatility strategy, stated:

Earlier this year, when spot prices were near highs and volatility was dropping to lows, there was a wave of interest in Lookback Options for hedging returns.

With the latest round of increases and volatility resetting, we are seeing them actively quoted again Analysts introduce that the current interest in retrospective options mainly comes from accounts outside of hedge funds, such as pure long-only asset management companies and private banks.

Nasdaq and technology stocks have generally become popular targets for options. Rocky Fishman, founder of ASYM 300, stated that the 10-day realized volatility of the Nasdaq 100 index has fallen to its lowest level since 2021:

Nasdaq and technology stocks have generally become popular targets because their volatility is particularly suppressed.

Market Environment Drives Demand for Protective Trades

With the Federal Reserve's interest rate decision, U.S. employment and GDP data, tariff deadlines, and the upcoming earnings season for large tech stocks, the market will face new challenges.

The seasonal trend of the Cboe Volatility Index typically rising from July lows in the third quarter, along with the upcoming earnings season and tariff deadlines, may drive more attention to hedging trades.

The recent resurgence of wild fluctuations in meme stocks in the U.S. market this month may also prompt institutional investors to seek protective trades rather than chase further gains.

In 2021, the surge driven by retail enthusiasm marked a euphoric phase in the stock market, but this trend quickly faded.

In the current market environment, investors are both worried about missing further upside opportunities and concerned about potential pullback risks, and this conflicting psychology is driving demand for more sophisticated risk management tools