If investors can overcome the psychological albatross that is “pure tariff chaos” and assuming cold-hearted markets continue to view the (very real) prospect of war with Iran as largely immaterial absent a transmission mechanism to corporate bottom lines, there’s some potential for a new equity melt-up.

This is about flows more than it is fundamentals, but anyone who knows modern market structure knows flows can be all that matter on short-term horizons.

The figure below gives you a sense of relative demand for near-term downside equity protection: We’re looking at 100%ile on a two-year lookback.

Suffice to say investors are hedged. Indeed, as Nomura’s Charlie McElligott wrote, they’re “over-hedged,” as evidenced not only by the steep SPX skew shown above, but by steep VIX call skew. Hold that latter thought.

This comes even as hedge funds have cut their exposure amid generalized angst around AI disruption risk, private credit concerns, tariff uncertainty and geopolitical friction. So: The market’s over-hedged and under-exposed.

The figures on the top row, below, show you three-month skew across the US benchmarks, while the figures on the bottom row show you call skew which, as you’d expect in an environment where market participants are over-hedged on the downside, is bombed out.

McElligott’s color-coded annotations do all the talking, but do note the bit that isn’t highlighted: Premium income strategies are a source of vol supply.

Part and parcel of the “destroyed” call skew is overwriting from the ever-expanding AUM of retail products which offer attenuated (i.e., capped) exposure to equity upside where the cap is an income-generating, sold call. There’s stop-in potential there.

“It’s not just the over-owned index downside that can roast and bleed-out on a spot equities rally,” McElligott wrote. “It’s also the under-owned right-tail, with OTM call-sellers potentially acting as ‘buyers higher’ into a spot rally.”

And then there’s the above-mentioned VIX calls. The real convexity lives in the VIX complex. The more investors “substitute” VIX calls for SPX puts when it comes to hedging crash risk, the more “oomph,” so to speak, in a scenario where vol resets lower. As Charlie put it, “the VIX motion is kinetic at the ends of its spectrum, tending to overshoot ‘up,’ of course, but then too getting slapped-down quickly as well.”

Circling back, this is all about flows, and it’s easy enough to dismiss as too esoteric to ponder and parse on days when the financial media’s churning out headlines like, “Dow slides as selloff ramps up following Trump’s global tariff hike.” But the point is to give you a sense of the behind-the-scenes structural setup. It’s about “if-thens.”

“If we can get spot equities to stabiliz[e], popular VIX calls [can] melt and have plenty of room to go lower,” McElligott said, summing it up. That, in turn, would “knock into the virtuous feedback loop” where there’s “delta-to-buy in equities futures as hedges roast, vol-scalers mechanically need to add back exposure as VIX resets lower and under-exposed investors risk turning ‘buyers highers,’ potentially bidding-up cheap calls.”