Analysis: Options specialists see stock rebound as chance to protect against declines

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Traders work on the floor of the New York Stock Exchange (NYSE) in New York, U.S., March 16, 2022. REUTERS/Brendan McDermid

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NEW YORK, March 23 (Reuters) – Risk appetite has rebounded on Wall Street after a rough start to the year, but some strategists warn the lull in volatility could be brief and urge investors to hedge against further stock market fluctuations.

The Cboe Volatility Index (.VIX) – an option-based measure of the 30-day expected volatility for US 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 coincided with a rally in the S&P 500 index (.SPX), which has halved its year-to-date losses, fueled in part by assurances from the Fed that the US economy is strong enough. to resist more aggressive monetary policy tightening as the central bank struggles to rein in rising inflation. The index is still down about 5% for the year after confirming a correction last month.

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

Catalysts for future volatility eruptions range from fears that the Fed’s hawkish tilt could push the economy into recession – an idea that’s rattling bond markets – to additional geopolitical uncertainty stemming from the invasion of Ukraine. by Russia, which Moscow calls a “special operation”. Read more

“In the absence of a protective buy request, the VIX will tend to soften…but as we saw in mid-February, that can change in the blink of an eye,” said Matthew Tym, head of equity derivatives trading at Cantor Fitzgerald. . “If I see the VIX drop a point or two, I start to think it’s at rock bottom.”

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 further stock market weakness.

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

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

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

The intense volatility has prompted some investors to reduce their exposure to equities in recent weeks, one of the possible reasons for the drop in demand for hedges.

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

“There’s just less hedging exposure,” said Ilya Feygin, senior strategist at WallachBeth Capital.

To be sure, analysts have also noted that sharp declines in the VIX have often preceded a short-term rise in stocks: the S&P 500 has historically returned 2.5% and is up 77% of the time after falling five days of 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 stabilize soon.

The VIX curve remains fairly flat throughout November, suggesting that traders expect markets to remain choppy for most of the year.

“This indicates volatility is staying where it is now for some time,” said Randy Frederick, vice president of trading and derivatives at the Schwab Center for Financial Research.

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

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