Who’s Afraid of the Big Bad Bear? Wall Street’s recent surge in volatility hedging may have more to

Discussion in 'Wall St. News' started by ajacobson, Sep 17, 2017.

  1. ajacobson

    ajacobson

    Sept. 15, 2017 10:20 p.m. ET


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    In early September, a survey of 214 institutional investors who manage $629 billion identified volatility as the world’s most undervalued asset. It was somewhat surprising. Volatility, after all, is an invisible, mathematical concept that essentially reflects what has happened, and what might happen, to stock, bond, currency, and commodity prices.

    The fund managers have since hedged their portfolios, apparently buying bearish index put options to offset any stock market declines through year’s end.

    “Only net 27% have not bought equity hedges,” wrote Michael Hartnett and Jared Woodard, the Bank of America Merrill Lynch strategists who conducted the survey. “The nine percentage-point increase in hedging is the largest jump in 14 months.”

    The futures market on the CBOE Volatility Index, or VIX, is priced as if the next few months will be more tumultuous than the present. The interest in hedging also coincides with a rise in fear mongering. Many investors, great and small, are worried that volatility is too low, stock prices are too high, and the end is nigh.

    “Fear sells,” says Stephen Solaka, managing partner of Belmont Capital, a money-management firm. “Institutional salesmen try to get people to trade by painting worst-case market scenarios.”

    Current hobgoblins include North Korea’s adventures in nuclear weaponry and the possibility that the Federal Reserve or European Central Bank will make a policy mistake that roils markets.

    Barely anyone notes that volatility is low because pricing models are reasoning that the future will be as nondramatic as the recent past. It’s easier to make the bearish case, especially if you work at a bank that is suffering from low trading volumes.

    Indeed, a cynical observer might say the recent interest in hedging reflects issues that have more to do with Wall Street’s innermost workings than anything else. Bank chiefs have warned about trading volume weaknesses. Also, each year, about now, institutional investors start thinking about their annual bonuses. This tends to make them more risk-averse.

    The stock market rally has pushed realized volatility ever lower, to the point that hedging historically high stock prices is not expensive. Hedging enables fund managers to protect their bonuses and year-to-date performance, just in case something upsets the market. If nothing roils the stock market, who cares? The fund managers spent other people’s money buying hedges.

    “At the end of the day, it all comes down to CYA,” said a strategist at a major bank who probably would be fired if identified.

    If the “bonus hedge” rationale makes sense, and you believe that President Donald Trump’s renewed talk of tax cuts will steady or boost stocks, there are ways to reduce risk without buying portfolio hedges, which has largely been a losing trade for years.

    THE MOST BASIC STRATEGY entails selling high in the stock market and buying low in the options market. By locking in profits on stocks and replacing them with generally low-volatility call options that expire in six to 12 months, investors reduce risk without sacrificing potential gains. Tax bills are a drawback, so consider that before acting.

    This is acutely boring, but it often works. If the market tanks, close out the calls and repurchase the sold stocks at lower prices.

    Because even paranoids have enemies, consider buying $20 strike VIX calls that expire in a month or two, if you find it hard to ignore the doomsday predictions. Such calls are perennially popular because they don’t cost much and are worth a lot if the market tanks. After a VIX spike, many investors use volatility-focused exchange-traded funds that profit from declines.

    These approaches lack the drama of fashioning big portfolio hedges in anticipation of a major stock drop, but simple is often best when it comes to managing risk.

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    STEVEN SEARS is the author of The Indomitable Investor: Why a Few Succeed in the Stock Market When Everyone Else Fails.
     
  2. Nice bear...
     
  3. S2007S

    S2007S

    Vix coming down to historical lows ...now below$10

    You can make extremely quick money buying the vix calls.....the vix is like a coiled spring ready to bust out...I'm going to buy some VXX today or tomorrow...looks like it could be ready for a bounce....
     
  4. hajimow

    hajimow

    You said surge in volatility. I do not see surge in V. V is in almost historic low. It does not mean that I am not bearish though.
     
  5. hajimow

    hajimow

    Today DOW is up 90 points but only 15 stocks of DOW are up. 16 are down. Very interesting. Maybe the sign of start of a correction. You do not need to short the market. You can just sell 50% of your long holdings and sit on sidelines. Better be safe than sorry.
     
  6. Trump is wooing Democrats to go along with his tax reform bill. He'd need only 51 votes to pass it. If passed, I think VIX would trend down further. it might make a new low.

    The Kimchi dictator wouldn't dare to fire his crackers. he's just posturing for a concession from the West. or else it would be suicidal!
     
    Last edited: Sep 18, 2017
  7. noddyboy

    noddyboy

    VIX under 10 now. Not sure if it will hold.