Battling The Fear of Inflation and Fear of Missing Out
The market has pinned volatility at a higher price because of the sell off, creating a perverse situation where protection is not just expensive, but also failing to provide much convexity as the market makes new lows.
But while this can limit immediate protection, it does provide opportunities to create income opportunities from this overpricing, which can in turn fund more protection as well as upside participation.
A Bloomberg Article touts "VIX Traders Are Piling Into Bets That Fresh Stock Pain Is Ahead".
"Volatility traders are putting their guard up just as US stocks bounce back, with options signaling the highest level of anxiety since right before the 2020 pandemic crash."
"Options hedging is showing signs of revival after staying subdued during the recent equity selloff. The rush for protection reflects investor uneasiness in the face of the S&P 500’s longest streak of gains in three months.
With a cost measure of VIX options hovering near the lowest level since 2019, traders are likely taking advantage of what looks like cheap insurance against the next bout of market chaos.
The hedging activity stands out given the fact that the VIX, known as Wall Street’s fear gauge, failed to hit new highs since March even as the S&P 500 careened to fresh lows."
One might use options to set up a portfolio to participate in market gains. Even after Q2 brough two unique circumstances hampering investors ability to protect their portfolios.
First, bonds failed to provide a buffer, selling off -12.5% (per AGG) alongside equities as rates rose significantly; and second, hardly any bid for Puts below the market, as evidenced by the VIX remaining -10% below its 2022 high despite the new lows in the S&P.
This sort of environment might enlist downside protective puts and long VIX positions to cut market losses. But while gains can be seen on those protective positions, the environment we were presented with kept a bit of a cap on those gains compared with other market sell offs like 2008 or March of 2020, where VIX more than tripled.
It’s a two way market now as much as ever.