Costs to protect stock portfolios from another blow after Fed rally hits 3-year low

by Joseph Adinolfi

Investors who bought calls on the Cbow Volatility Index in July — known as Wall Street’s “fear gauge,” or simply “VIX” — this summer to help offset potential losses in their equity portfolios. Have found they didn’t need that protection anyway.

Instead, the S&P 500 index rose more than 9% in the month to Friday from July, recording its biggest one-month gain in nearly two years.

But demand for VIX call options still remains as the call-put ratio soared to nearly 4 earlier this month, its highest level in 2 1/2 years, according to data from Cboe, as investors raised their own Scrambled to save him from danger of further damage. , after US stocks fell to their lowest level since the end of 2020.

However, this week, stocks shifted to a more upbeat pace as stocks edged higher in their latest phase after Wednesday’s meeting of the Federal Reserve. The S&P 500 is up more than 5% since markets opened on Wednesday, as equity bulls were buoyed by the Fed’s latest 75 basis point interest rate hike and Chairman Jerome Powell’s comments during the press conference, in which His belief was also included that the US economy is not in recession.

READ: Was Fed’s Powell Dovish Or Not? 4 highlights from Wednesday’s press conference

As a result, the VIX fell to its lowest level since April, and the VVIX, which measures the implied volatility of the VIX index, fell below a three-year low of 80, according to data from FactSet. VVIX levels are important to investors and traders because the VIX’s implied volatility is the main factor used to price VIX-based options. According to FactSet, with implied volatility being so low, the price of a one-month out-of-the-money VIX call has fallen to its lowest level since the summer of 2019.

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This may make volatility options attractive to some investors, perhaps to pension funds or other large real-money players who want to cheaply hedge their portfolios. But Danny Kirsch, head of the options desk at Piper Sandler & Co., said there are good reasons why VIX options are so cheap right now.

“The reason VIX calls are so cheap is because they don’t work,” Kirsch said.

According to FactSet data, the VIX went down to a low of 21.31 on Friday. This is the lowest level since April 21. But while volatility was rising earlier this year as stocks sold out sharply, the VIX never made it as high as during other market downturns.

For example, the VIX rose to 85 during the COVID-induced selloff in March 2020. By comparison, the VIX has yet to surpass the 40 level at any point during 2022, even though US stocks endured their worst first half in more than 50 years. ,

According to Kirsch, the reasons why long-term volatility trading is not useful this time are numerous and complex. A key factor relates to the demise of short-volatility exchange-traded notes such as the VelocityShares Daily 2x VIX Short-Term ETN, which was delisted by Credit Suisse back in 2020, although it still trades over the counter.

“You don’t have these massive short tails that need to be covered,” Kirsch said, explaining that because there are few low-volatility products, there is less demand for VIX calls when markets become volatile and short- Holders of volatility products are required to cover their losses or hedge their exposure.

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Looking ahead, it’s probably understandable that unrealized volatility — which is the VIX measure because the index is based on near-term options prices on the S&P 500 — has been so low.

As Kirsch pointed out, a significant amount of “event risk” has just been taken off the market calendar. For example, investors got a reading on second-quarter US GDP on Thursday, and Friday ended the busiest week for S&P 500 corporate earnings in the quarter.

Aside from the Federal Reserve’s summer stay in Jackson Hole, Wyo., investors won’t hear from the Fed again until a September policy meeting, which could be the next opportunity for the central bank to raise interest rates.

“We are in the middle of summer, with less clear catalysts, not another Fed meeting until September,” Kirsch said.

US shares advanced for a third-straight day on Friday, with the S&P 500 rising 1.4% to 4,130.29. The Nasdaq Composite rose 1.9% to 12,390.69, while the Dow Jones Industrial Average rose 1% to 32,845.13.

-Joseph Adinolfi

(END) Dow Jones Newswires

07-30-22 1144ET

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