The higher it rises, the worse it falls! Nomura warns: If the S&P drops 5% in a single day, it will trigger an even more intense sell-off.

The current surge in the U.S. stock market is building a dangerous trigger for a reversal.

Nomura Securities strategist Charlie McElligott warns that mechanisms driving this rally—such as options, leveraged ETFs, and volatility control—are creating self-reinforcing positive feedback during market gains. Once the trend reverses, the same mechanisms could hammer the market downward with equal or greater force.

The S&P 500 index broke above 7,500 points for the first time this week, but McElligott’s model shows that a single-day 5% decline could trigger passive selling totaling up to $187 billion from options traders, leveraged ETFs, and volatility control funds—forming a “death spiral” of “selling as it falls.” He directly describes this outlook as “jumping off a higher cliff.”

Meanwhile, interest rate risk is resurfacing. The 30-year U.S. Treasury auction yield rose to its highest level since the August 2007 quantitative crash, inflation remains high, global central banks are raising rates, and long-term U.S. Treasury yields continue to climb—becoming the biggest potential hedge against this stock market frenzy.

Negative Gamma Vortex: an accelerator of gains and an amplifier of crashes

McElligott points out that the explosive rally since late March has been mainly driven by “real and synthetic” negative gamma flows, rather than active buying by proactive funds. Many active mutual funds, market-neutral funds, and macro hedge funds have badly missed this move, being forced to chase the rally, further boosting upward momentum.

Specifically, active mutual funds are underweight in the largest tech stocks—year-to-date, large-cap tech AI stocks are up 38%, and semiconductors even more at 59%—which are the main sources of index returns. Market-neutral funds, which tend to be long quality and short high-volatility stocks, have been severely squeezed during this high-beta surge—“S&P high-beta/low-beta” factors have risen 26.1% since March 30. Macro funds, previously bearish and over-hedged after the Iran conflict, missed the right tail of the rally and are now forced to buy large amounts of call options to catch up.

This “more rise, more buy” structure manifests in the options market as a steepening of call skew, creating a rare pattern of “spot prices rising along with volatility.” McElligott cites data showing that the 3-month at-the-money volatility of SMH (semiconductor ETF) is at the 100th percentile historically, with the top 10 and top 50 stocks’ 3-month at-the-money volatilities at the 99th percentile.

Leveraged ETFs: the core trigger for $187 billion in passive selling

Beyond the negative gamma dynamics, the leveraged ETF complex is pushing risk to new heights. McElligott’s data shows that the total size of leveraged ETFs has reached $1.79 trillion, with 85% heavily concentrated in tech, AI, semiconductors, and the Mag7 themes, overlapping significantly with the options chase described above.

Over the past month, daily rebalancing of leveraged ETFs has generated over $100 billion in net buying, including $38.1 billion in semiconductors, $41.8 billion in tech, and $11.6 billion in Mag7 stocks. This scale makes leveraged ETF daily rebalancing one of the largest sources of “synthetic negative gamma” in market history.

McElligott’s model estimates the passive selloff size under different decline scenarios: the larger the drop, the greater the hedging demand from options traders, the more leveraged ETFs need to rebalance, and the more volatility control funds reduce holdings—creating a “more decline, more selling” vortex. In the event of a 5% single-day drop in the S&P, these three mechanisms combined could trigger $187 billion in passive selling. His blunt warning: “This just makes the final deleveraging event happen from a higher cliff.”

Interest rate risk reignites, and inflation tail risks cannot be ignored

McElligott emphasizes that behind the market frenzy, macro risks are quietly accumulating. The 30-year U.S. Treasury yield has risen to its highest since the August 2007 quantitative crash, with ongoing long-term supply pressures, prompting more traders to focus on interest rate risks.

On inflation, he states that U.S. inflation is “ridiculously high” and trending in the “wrong direction.” Unresolved shocks from Iranian energy and petrochemical supplies, along with record-fast depletion of emergency inventories, could activate “inflation tail risks” once inventories run out. Meanwhile, the U.S. economy is currently closer to “overheating” than recession, supported by large fiscal deficits, accelerated capital spending, manufacturing and industrial acceleration, strong retail sales, and a 6% nominal GDP growth rate.

In this context, the global central banks targeting a single inflation goal are increasingly pricing in actual rate hikes, which are beginning to influence the Fed’s expectations. McElligott warns that the MOVE index (U.S. Treasury volatility) could again become a downward pressure on stocks within the next one to two months, especially with a new Fed chair taking office.

Reversal window: post-options expiry or key nodes

McElligott also offers specific timing for potential reversals. He notes that the phenomenon of “QYLD short at-the-money call repurchase” observed this week, combined with the gamma release after Friday’s options expiry (Op-Ex), could open a window for a market reversal next week—though earnings from Nvidia after May 20 could temporarily delay this process.

On a microstructure level, he believes that when SMH’s single-day decline widens from -5% to -12%, the rebalancing sell vortex will activate, pushing the S&P 500 down to around -2%. At that point, the positive correlation between spot prices and volatility will begin to reverse—beyond -2.5%, volatility will be passively lifted, further depressing stocks and creating a symmetric negative feedback loop.

In terms of hedging strategies, McElligott notes that the market currently favors a 1x3 ratio spread of put options on SMH as a convexity hedge, and is beginning to recommend long skew options with longer maturities (e.g., July expiry)—since almost no one is holding downside protection right now. When selling pressure hits, forced buying of puts will sharply steepen the index options skew.

Risk warning and disclaimer

        The market carries risks; investment should be cautious. This article does not constitute personal investment advice and does not consider individual users’ specific investment goals, financial situations, or needs. Users should consider whether any opinions, views, or conclusions herein are suitable for their particular circumstances. Invest at your own risk.