The stock market pricing data reveals a pleasant surprise: investors are not all that complacent.
With the U.S. stock market touching a record high and with daily stock gyrations nearing their multi-decade lows, a few investors had raised concerns regarding the lack of fear in the market; however data from the U.S. equity options market suggests that investors are far from being complacent.
Investor positions in options on the S&P 500 index and on the CBOE Volatility Index shows that in the last few months, they have been gradually adding to their hedges.
“We didn’t see it on our desk and no one seems to care much about hedging but somehow it’s happening,” said Jim Strugger, a derivatives strategist at MKM Partners, New York. “It’s sort of under the surface, more like stealth hedging”.
So far, the S&P 500 index has jumped by 16% this year and is on the road to post gains for eight straight month, its longest streak since before the 2007-2009 financial crisis.
In contrast, earlier this month, the CBOE Volatility Index, better known as the VIX, and followed for expected near-term stock market volatility, closed at a record low.
As a result, some investors have become alarmed that heightened reliance on strategies that profit from continued calm in stocks, and months of frustration over hedges that have amounted to nothing since the market was in a bullish mode, have created a condition where the market is vulnerable to a shock.
However, data from the options market suggests that investors are not as vulnerable to a sell-off in stocks as the anemic level of the VIX would suggest, said analysts.
Case in point: according to data from analytics firm Trade Alert, on the S&P 500 index options, there are 2.1 puts open for each open call contract; this is close to the most defensive measure investors have taken over the last five years.
An index call option gives the holder the right to buy the value of an underlying index at a fixed level in the future while a put conveys exactly the opposite; a put is usually used to protect against declines in the index.
While some of put activity may be due to investors selling puts to come out of their previous positions and generate income, however brisk put volume suggests renewed interest in protective positions, said analysts.
“More often than not, even in the world we live in where volatility is so attractive to sell, you can make a fair assumption that people are buying options,” said MKM’s Strugger.
Similarly, VIX options show elevated positioning in out-of-the-money VIX calls, contracts that are not profitable yet but would reap gains if volatility spikes.
“When open interest on VIX out-of-the-money calls is really high, I would tend to think that the market is more aggressively hedged,” said Aashish Vyas, director of portfolio strategy at Durango, Colorado-based Swan Global Investments.
“To me, that matters more than the absolute level of the VIX,” said Vyas.
While the data does not suggest that the market is turning bearish, as would be suggested if the VIX were to shoot up, it however implies that investors have hedged against volatility in the coming months.
“I don’t think the market is complacent,” said Joe Tigay, chief trading officer at Equity Armor Investments in Chicago. “People have downside protection”.