The option market is currently signaling a relatively low probability of a significant downturn for the S&P 500 over the next quarter, according to Piper Sandler.
According to the investment bank, there is a 6% chance of the index falling by 10% within the next three months. However, they suggest that this figure could be even lower at around 5%.
Piper Sandler's analysis of the risk-neutral distribution indicates that the market may be overly optimistic about upside potential. They believe the market is assigning an excessive probability of a 10% increase in the S&P 500.
Despite the low probability of a downturn, the firm warns that this overvaluation of upside potential could eventually lead to a correction in the market.
Analysis:
In simple terms, Piper Sandler is saying that while the chances of a significant market downturn in the next three months are low, investors should be cautious about the overly optimistic expectations for market gains. This could potentially lead to a correction, which is a drop in stock prices to more reasonable levels. So, investors should be mindful of the risks and not get too carried away with the current market optimism.