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Analysis: Options mavens see stock rebound as chance to pick up downside protection

March 23, 2022
in Latest Financial News
Reading Time: 5 mins read
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NEW YORK, March 23 (Reuters) – Risk appetite has rebounded on Wall Street after a brutal start to the year, but some strategists warn the lull in volatility may be brief and urge investors to guard against more stock market gyrations.

The Cboe Volatility Index (.VIX) – an options-based measure of expected 30-day volatility for U.S. stocks that some call Wall Street’s fear gauge – fell to a five-week low of 22.81 on Tuesday, just two weeks after closing at a one-year high.

The move has coincided with a rally in the S&P 500 index (.SPX), which has halved its year-to-date losses, fueled in part by the Fed’s assurances that the U.S. economy is strong enough to withstand more aggressive monetary policy tightening as the central bank fights to tamp down surging inflation. The index is still down about 5% for the year after confirming a correction last month.

Some options strategists say the recent gains could be fleeting and are advising clients to buy hedges against volatility, which have become cheaper in recent days as demand for portfolio protection has ebbed.

Catalysts for future volatility eruptions range from worries that the Fed’s hawkish tilt will drag the economy into recession – an idea that is roiling bond markets – to further geopolitical uncertainty stemming from Russia’s invasion of Ukraine, which Moscow calls a “special operation.” read more

“With no demand for buying protection, the VIX is going to have a tendency to soften … but as we saw in mid-February, that can change in a heartbeat,” said Matthew Tym, head of equity derivatives trading at Cantor Fitzgerald. “If I see the VIX down another point or two, I am starting to think that’s bottoming out.”

That sentiment was echoed by strategists at BoFA Global Research, who believe worries about high inflation, slowing growth and a hawkish Fed are likely to fuel more stock market weakness.

“We see the risk-on price action and lower cost of protection not as a rallying cry, but rather an opportunity to reload on hedges,” they wrote in a note on Tuesday.

An S&P 500 put option that would guard against a 10% decline in the index through mid-June costs about 30% less now than a week ago, Refinitiv data showed.

Meanwhile, the one-month moving average of open put contracts against open calls on the SPX index, a measure of defensive positioning, is at its lowest since July 2020, according to Trade Alert data.

Intense volatility prompted some investors to lower exposure to stocks in recent weeks, one possible reason why demand for hedges has fallen.

A BofA Global Research survey for March showed fund manager’s cash levels at their highest since April 2020, while a measure of equity positioning tracked by Deutsche Bank recently slipped to the lowest since September 2020.

“There is just less exposure to hedge,” said Ilya Feygin, senior strategist at WallachBeth Capital.

To be sure, analysts have also noted that sharp drops in the VIX have often preceded short-term upside in stocks: the S&P 500 has historically returned 2.5% and been up 77% of the time following a five-day drop in the VIX, wrote Christopher Murphy, co-head of derivatives strategy at Susquehanna International Group.

Others, however, point out that the VIX has only closed below its media average of 18 three times this year and believe it is unlikely to settle down soon.

The VIX curve remains quite flat all the way through November, suggesting traders expect markets to stay choppy throughout most of the year.

“It points to volatility remaining around where it is now for a while,” said Randy Frederick, vice president of trading and derivatives for the Schwab Center for Financial Research.

Reporting by Saqib Iqbal Ahmed; Editing by Ira Iosebashvili and Richard Chang

Our Standards: The Thomson Reuters Trust Principles.

Source: Reuters

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