Trend followers keep buying equities on volatility declines: BofA

Bank of America reports that trend-following CTAs have reached maximum long positions in U.S. equities, particularly S&P 500 and Nasdaq 100 futures, driven by declining realized volatility and rising option gamma, which increases the risk of significant unwinds despite current distant stop-out levels. Concurrently, CTAs have increased long exposure to U.S. Treasuries and gold, turned net long aluminum, and largely remain short the U.S. dollar, with tightening stop-loss levels in GBP and AUD indicating potential reversal risks.

Analysis

According to a Bank of America report, systematic trend-following funds (CTAs) have established maximum long positions in key U.S. equity futures, including the S&P 500 and Nasdaq 100, driven by declining realized volatility. S&P 500 longs are reportedly at their highest level since December 17, 2024. This extreme positioning heightens the risk of a significant and rapid unwind should a market reversal occur, though stop-out levels are currently described as distant. The low volatility environment is being technically reinforced by a surge in S&P 500 option gamma, with the one-month average level doubling to $7.6 billion and current gamma standing in the 74th percentile. Across other assets, CTAs have also adopted a 'most stretched long' posture in 2-year, 5-year, and 10-year U.S. Treasury futures. In commodities, gold positioning is at maximum long after five weeks of gains, while a new net long in aluminum is flagged as being at risk of stop-outs. In foreign exchange, the consensus position remains broadly short the U.S. dollar, but with stop-loss levels in sterling and the Australian dollar now within 64 to 78 basis points, the potential for a reversal in those pairs is increasing.

Key Decisions for Investors

• Given the 'maximum long' CTA positioning in equities, investors should recognize the elevated risk of a sharp, technically-driven sell-off from this crowded trade and consider monitoring for catalysts that could trigger an unwind.
• The concurrent stretched-long positioning in both equities and U.S. Treasuries challenges traditional diversification; portfolios should be re-evaluated for risks associated with a potential breakdown in the negative stock-bond correlation.
• Monitor key tactical levels in specific markets, such as the approaching stop-losses in GBP/USD and AUD/USD which could precipitate a U.S. dollar rally, and the price of aluminum where new CTA longs are vulnerable.
• Recognize that the high option gamma currently suppressing S&P 500 volatility is a temporary stabilizer, and its potential decline, particularly post the September quarterly expiry, could reintroduce market volatility.