A bumpy week for the S&P 500 Index prompted long-complacent traders to have a look at the hedges that they had ignored for months.
Demand for broad-market insurance fell to its lowest level in several years in the primary quarter as U.S. stocks posted a series of recent highs despite rising geopolitical tensions and uncertainty over rates of interest. This week that modified as the need to guard against a downturn increased through a variety of measures.
“People are starting to realize that we’ve got through these first three months of the year – all with interest rates rising and with the increasing likelihood of rate cuts,” said Joe Mazzola, director of trading and training at Charles Schwab & Co. “At some point something has to give.”
The Cboe volatility index, often called VIX, closed Thursday at its highest level since November before tumbling on Friday as U.S. stocks rose. The index – a measure of the S&P 500’s 30-day implied volatility based on out-of-the-money options prices – still remained above its 200-day moving average.
Investors have been slowly hedging since late March, pushing the price of bearish three-month put options to their highest premium over bullish contracts since mid-January. These positions complement insurance that has received more attention this yr – tail risk hedges, however protect against a serious crash and never against a minor correction.
Some investors use spreads, which supply less protection against a downturn but cost much lower than outright contracts. Susquehanna International Group cited recent put spreads within the S&P 500, the tech-heavy Nasdaq 100 and the Russell 2000, which are sometimes seen as a gauge of the health of small caps waiting for declines.
Stephen Solaka of Belmont Capital Group, who manages hedging strategies for asset management firms and institutions, said more clients have been asking for portfolio hedges tied to each stock benchmarks and individual technology firms.
“It depends on the pricing and the lead time we had,” he said. Solaka says the request is sensible: After the S&P 500’s rapid rally, investors will probably want to shield their profits. “It is natural.”
These days, traders’ fears are focused on various unknowns: geopolitical tensions, the upcoming US presidential election, first-quarter earnings reports and – after all – central bank policy. This latest wild card got here to the fore last week after Federal Reserve Chairman Jerome Powell said bankers didn’t have to rush to ease borrowing. The Fed’s Neel Kashkari further dampened the mood when he raised the likelihood that there can be no rate of interest cuts in 2024.
A surge in put volume related to the iShares iBoxx High Yield Corporate Bond ETF (ticker HYG) signaled that investors are bracing for one more Fed disappointment. The hedges related to the fund would likely repay if the Fed’s hawkish policies push the interest rate-sensitive fund lower.
“If you think about what’s driving some of the real macroeconomic volatility, it’s interest rates,” said Alex Kosoglyadov, managing director of equity derivatives at Nomura Securities International, mentioning that fewer cuts than markets expect are triggering stock moves could. “The Fed represents a risk that could push the market lower.”
The options positioning reflects the trend within the stock market, which favors established mega-caps over riskier stocks. Growth and high-quality exchange-traded funds saw massive inflows in comparison with the meager inflows of value funds in March.
According to Rohan Reddy, research director at Global X Management, demand for cover relies on traders’ expectations. As consensus for a soft landing grows, unwelcome surprises can instill a little bit of fear in even probably the most fearless bull markets.
“Of course there is a real possibility that things will get rocky. In this case, there may be a greater desire for protection,” Reddy said.
