Investors are losing their taste for chasing US stock gains in the options market and are eyeing downside protection as the S&P 500‘s rally wobbles at the start of 2024.

The S&P 500 fell 1.7 per cent in the first three trading days of the year, its worst stumble out of the gate since 2016. That comes after a surge in which the S&P 500 rose 11 per cent during a dizzying fourth-quarter rally. The index gained 24 per cent in 2023.

Many believe a pullback is par for the course after such sharp gains. The most widely followed gauge of downside protection - the Cboe Volatility Index - is trading within two points of a four-year low hit late last year, a sign that investors remain sanguine. As of midday on Friday, the S&P was up around 0.3 per cent, possibly on track to snap its four-day losing streak.

Nevertheless, other barometers show investors may be expecting more speed bumps in the near term. One measure of two-month S&P 500 skew - an options market gauge for the relative demand for upside call contracts versus downside put contracts - has crept up to its highest level since late October, though it is still near a multiyear low hit last month.

The tech-focused Nasdaq Composite and the Russell 2000 index of small-cap stocks show similar upticks in skew measures. Calls convey the right to buy shares at a fixed price in the future and are favored by investors looking to place relatively inexpensive bets on stock price gains.

Steve Sosnick, chief strategist at Interactive Brokers, said the recent stumble in stocks has prompted investors to take a more balanced approach to risk following a rally in which many market participants chased the gains in equities.

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“We were euphoric into the end of the year,” he said. “It wasn’t just a modest end-of-the-year rally ... this was ferocious, buy everything, pay any price, stuff,” Sosnick said, noting robust activity in upside call options in December.

Some US data has bolstered the case for a cautious outlook. US employers hired more workers than expected in December while raising wages at a solid clip, Friday’s report showed, casting some doubt on financial market expectations that the Federal Reserve would start cutting interest rates in March.

That data was counterbalanced by a report showing the US services sector slowed considerably in December, a survey showed on Friday.

A further test could come next week, when the US is set to release its highly awaited consumer price report and earnings season kicks off.

December’s rush into upside calls may be one reason skew measures slipped to historic lows last month, as many were fearful of “missing out” on the rally in the final weeks of the year, said Christopher Jacobson, a strategist at Susquehanna Financial Group.

With the rally running into turbulence at the start of the year, investors have been less inclined to bet on upside, helping skew measures rebound, Jacobson said. REUTERS