They’re hedging downside again. A little bit anyway.

For months, the options space was defined by the juxtaposition between negligible demand for downside protection against persistent interest in upside optionality given the never-ending index melt-up.

That conjuncture resulted in a pancaked skew, which in turn reduced the risk that any nascent selloff could morph into something more serious through familiar selling-begets-more-selling “doom loops.”

Although it’d be premature (and that’s an understatement) to suggest the tide’s turning, skew was bid ahead of the Fed this week, and in the context of an equity rally that’s at least slowed down, even as it certainly hasn’t reversed.

“Does 0%ile to 6%ile count?!” Nomura’s Charlie McElligott joked on Tuesday.

As the figure above shows, there’s some movement. Index hedges, Charlie said, evidenced demand in recent sessions amid what he described as “unease” across markets.

“The equities vol [space] is taking note of some of the recent excesses, as well as hawkish repricing scenarios which have been building in rates, and showing just the slightest bit of behavior change which could leave us exposed to movement, especially with the Fed on Wednesday coming out of the morning’s VIX expiration,” McElligott said, adding that in addition to the rare steepening in SPX skew (shown above), systematic positioning is “asymmetrically tilted towards de-allocation” following a period of dialed-up exposure into suppressed vol.

Note that JPMorgan’s recommending long vol expressions amid risk premia the bank views as dangerously compressed. In credit, the bank recommended LQD puts, noting that the negative spread-rate correlation implied by LQD options is at multi-year extremes. As for stocks, JPMorgan favors resettable put spreads on the S&P.

Coming back to Charlie, he said Tuesday that although there are “some indications that we are more open to a downside move than we have [been] in a number of months,” the same caveats generally apply. There’s a Pavlovian response function that says you sell vol on any meaningful expansion. Those flows can become self-fulfilling, particularly in the presence of large (and increasing) vol supply from the expanding universe of buy-write exchange-traded products.

On Nomura’s estimates, more than $240 million of monthly vega supply now originates from the options premium income / VRP space. “This is the flow that arrests developing selloffs and ultimately acts to reverse them,” McElligott wrote. “Nothing about the Fed’s dot plot will change that.”

“Call overwriting ETFs have become a large source of volatility supply that has been increasingly weighing on market volatility levels,” JPMorgan said flatly. “Capital is likely to be relatively sticky (and any outflows fairly gradual) from these strategies, suggesting their market impacts are likely to persist for some time.”

Charlie went on to describe client discussions. “If we were to get any sort of vol squeeze / spot selloff, I think eventually that sees a local spot index dip get bought while a vol pop gets sold, as market conditions still remain constructive economically for corporate earnings in the medium-term,” he said, before reminding market participants that central banks’ reaction function is still very asymmetric (i.e., the bar to add more cuts is very low versus an impossibly high bar to resume hikes) while fiscal support’s still “running in the background.”