For professional asset managers on Wall Street, the current biggest 'pain trade' is stocks continuing to rise after a two-year bull market of substantial gains.

There are ample reasons to expect that as buying investors catch up, stocks will continue to climb, as they aim to match benchmark indices like the s&p 500 index. According to FactSet data, as of Tuesday, the s&p 500 index has risen nearly 23% since the beginning of 2024.

This is the view of Charlie McElligott, strategist for Nomura Securities' Nomura Securities global markets americas business, who explained on Monday how hedge funds, systematic traders, CTAs, and other seasoned investors are so focused on protecting their portfolios from sell-off risks that they overlook preparing for the continued strong uptrend, known as the 'right tail outcome'.

The Chicago Board Options Exchange Volatility Index (VIX), known as the 'fear index', and other indicators measuring hedging demand, such as the skewness of options related to the SPDR s&p 500 ETF, reflect this sentiment, which may be imposed by risk management personnel at some asset management firms to portfolio managers.

Given the countless risks that may arise, as well as the two brief shocks experienced by the US stocks in recent months, this is not surprising.

Nevertheless, this cautious stance will weigh on fund performance, even though history shows that whenImplied volatilityWhen at or above the current level, stocks appear quite promising for prospective returns in the next year.

Even as the S&P 500 index hit its 46th closing high of the year on Monday, the VIX has significantly increased, hovering around 20, slightly above its long-term average, according to FactSet data. This unusual combination indicates that many on Wall Street still feel uneasy about the potential risks of an uptrend, especially with the upcoming U.S. presidential election.

According to Nomura Securities' data, macro funds and long-short hedge funds have lagged behind the S&P 500 index in the past three months, trailing the index by 7.3 and 2.2 percentage points respectively. This level of underperformance is quite significant compared to historical trends.

Nomura points out that if U.S. stocks continue to rise, these companies and others may eventually be forced to catch up by purchasing out-of-the-money call options.

“FOMU”

Analysts at Goldman Sachs trading desk indicated in their latest report that buyer companies' hedging activities have been shifting, as portfolio managers are showing an increased demand for call options. The team even coined a new abbreviation to describe this behavior: “FOMU,” or “Fear of Materially Underperforming” the stock market benchmark.

Goldman Sachs believes companies have ample reason to chase the rise in U.S. stocks, as it is expected that once most large American companies end their buyback blackout period later this month, funds from some corporate buyers will accelerate inflows into the stock market.

But that's not all. U.S. households typically increase their stock purchases after presidential elections, considering November and December historically strong months for market returns. With implied volatility expected to decrease once the dust settles after the election, this might encourage systematic funds and multi-fund management companies to increase their shareholdings before year-end.

Goldman Sachs team stated that, at the same time, by the end of this fiscal year, mutual funds should face reduced tax-related selling pressure.

As the old hedging expires, traders need to open new call positions. Options traders will be forced to hedge their exposure by purchasing S&P 500 index futures, further driving the rise of US stocks.

Goldman Sachs pointed out that ultimately, systematic funds and CTA, and even long-short discretionary fund managers, will be compelled to increase their exposure to stocks, adding more 'fuel' to the 'rise.Circuit breakerstyle increase'.

Editor/Lambor