U.S. stocks grind without retreat; UBS recommends a "1 Long 2 Short" options strategy to bet on a moderate rise in the S&P

As the long-term bull market in the U.S. stock market seems to have entered a "slow and steady cautious upward mode," it has been quite a painful "grinding" journey for traders who originally hoped that U.S. President Donald Trump's global tariff policy would interrupt this rally that has lasted for more than four months, as well as for those who expect the AI boom led by the seven giants to continue to support the strong rise of U.S. stocks.

Maxwell Grinakov, head of U.S. equity derivatives research at international banking giant UBS, stated that although the crazy rally that has repeatedly set historical highs may not continue, those willing to bet on its continued rise might consider adopting a moderately bullish options trading strategy known as a "call ratio spread," and noted that this strategy has been widely adopted by institutional clients since June.

The main content of this strategy includes buying one near-the-money call option, which means that if the U.S. stock market benchmark—the S&P 500 index—slightly rises next month, profits can be realized. To fund this options trade, he suggests selling twice the number of call options at significantly higher strike prices.

From a fundamental perspective, the key to implementing this strategy lies in selecting a level that an investor believes the S&P 500 index will reach in a month, while choosing a higher S&P 500 index level that the investor believes is unlikely to be reached at the expiration of the options for the call option selling operation.

This options strategy bets on a moderate upward movement of the index while being unlikely to exceed the higher short strike price: if the market "slowly rises" to near the upper strike price, the return is optimal at expiration; however, if it surges significantly beyond the upper strike price, there may be unlimited upside risk due to the net short position of one call option.

When the index slowly climbs, and implied volatility stabilizes or declines, the near-the-money call option profits + the time decay of the two short high-price calls benefits the overall position; however, if an unexpected surge occurs, it is necessary to roll/hedge the risk of the naked short position above (for example, by covering one short position or moving up the strike price of the option). Therefore, the Call ratio spread strategy is equivalent to using a 1 long 2 short call combination to bet on a "moderate upward" trend at a low cost (even receiving premiums) while managing the maximum potential unlimited loss above with a profit/risk strategy.

"The end result is that when the market slowly and steadily rises, the one call option you hold in your long position will earn a profit," Grinakov explained. "And the two times the number of call options you sold are usually set at a strike price that you believe the S&P 500 index will far from reach before expiration."

The trend of setting new highs is hard to stop, but it may enter a slow bull phase

Grinakov first proposed this options trading suggestion to clients in early June when the U.S. stock market experienced a brief consolidation, and the overall performance has been good since then. There are ample reasons to believe that the current market is likely to continue to profit—especially after the benchmark index achieved unexpectedly strong earnings reports, coupled with inflation data that broadly met expectations, quietly climbing to new highs, while extremely weak non-farm payrolls have also boosted market expectations for an upcoming Federal Reserve rate cut At the same time, the expectation of a "Goldilocks" economy (i.e., neither too hot nor too cold, maintaining moderate growth and stable low inflation) is cooling, while expectations of stagflation and recession are rising, which may lead the S&P 500 index to experience a slight pullback or a significant slowdown in its upward momentum.

"Given that many strategists expect volatility in the coming months, but at the same time suggest buying on dips, it is hard to imagine a very large-scale pullback without a real recession in the U.S. economy," said Chris Zaccarelli, Chief Investment Officer of Northlight Asset Management.

A team of strategists from Citigroup has raised its year-end target for the S&P 500 index from 6,300 points to 6,600 points, and expects it to rise to 6,900 points by mid-2026. This bullish report from Citigroup indicates that the "long-term bull camp" for U.S. stocks on Wall Street is growing larger. Before Citigroup raised its expectations for U.S. stocks, some market forecasters, including Michael Wilson, Chief U.S. Equity Strategist at Morgan Stanley, had already turned more optimistic about the S&P 500 index. Morgan Stanley expects a 5%-10% pullback in U.S. stocks in the short term, but views the pullback as a buying opportunity—mainly due to the strong earnings growth and AI capital expenditures of tech giants like Nvidia, Microsoft, and Google. Therefore, the firm previously raised its target price for the S&P 500 index significantly to 7,200 points, expecting to reach that level by mid-2026.

The VIX index is also reinforcing the "grind higher" bull market logic

In other corners of the options market, traders also seem to anticipate further gains in the future, but the pace of increase may slow down or even experience a significant pullback in the short term.

Some investors who previously chose aggressive hedging are abandoning their pessimistic positions, pushing the Chicago Board Options Exchange Volatility Index (VIX) — which measures the expected volatility of the S&P 500 index over the next month — down to its lowest level since Christmas Eve last year. On Tuesday, the VIX index fell to a level nearly identical to the "10-day actual volatility" of the S&P 500 index, marking the first time since late May, indicating that market concerns about a sell-off triggered by tariffs are fading.

"The sharp decline in the VIX index — which was above 20 points earlier this month and has now dropped to around 14 — is due to the surrender sentiment among those hedgers betting on the August tariff turmoil," said Mandy Xu, Head of Derivatives Market Intelligence at Cboe Global Markets Inc. "The continuous rise in the U.S. stock market is frustrating many hedgers, who are now choosing to abandon some aggressive hedging positions," she stated in an interview.

"In the current macroeconomic and market environment leaning bullish, the call ratio spread is a fairly common and effective trading paradigm," Mandy Xu said. "The current market wants to express the view that the stock market will gradually rise, rather than enter a trajectory of more than a 10% significant pullback."

The Upcoming "Jackson Hole Moment" is Worth Investors' Focus

There is a risk event that may disrupt the "slow and steady" grinding bull market pace of the S&P 500 index from the end of this month to early next month, which is Federal Reserve Chairman Jerome Powell's scheduled policy speech at the global central bank "Jackson Hole Economic Policy Symposium" on August 23rd local time—this annual global central bank event is often used to signal the short- to medium-term outlook of U.S. monetary policy. Past Federal Reserve chairs, including Powell, have tended to release hawkish or dovish signals at the Jackson Hole meeting to manage market expectations in advance.

Although federal funds futures traders have currently fully priced in a 100% expectation of a 25 basis point rate cut in September, and a total of 2.5 equivalent rate cuts by the end of the year—indicating that most traders are betting on the Federal Reserve cutting rates three times at 25 basis points each for the remainder of this year, this also suggests that the Federal Reserve may choose to cut rates at all three remaining FOMC monetary policy meetings in 2025.

San Francisco Fed President Mary Daly recently stated that given the increasing signs of a weakening U.S. non-farm employment market and the absence of sustained inflation driven by tariff policies, the timing for the Federal Reserve to restart rate cuts is approaching, and it is more likely that the Federal Reserve will need to cut rates more than twice this year. 2026 FOMC voting member Neel Kashkari indicated that the U.S. economy is slowing, and he expects two rate cuts by the end of this year, but tariff policies remain a "significant uncertainty."

However, if Powell delivers a particularly hawkish speech due to concerns about inflationary pressures from Trump's tariffs, market expectations for rate cuts may suddenly shift, leading to market volatility. Nevertheless, even if this event is priced in by the market, it is expected not to cause significant fluctuations in the S&P 500 index. A team led by Citigroup's equity trading strategist Stuart Kaiser stated that the implied volatility priced into the options market for the day of Powell's speech is about 0.67%, lower than the 0.83% implied volatility on the day of earnings release for "AI chip leader" Nvidia (NVDA.US) the following week