A TIME FOR TAIL RISK HEDGES IN BOTH DIRECTIONS
• Options Activity: In total, there were about 3 times as many put transactions today as call transactions. If those are predominantly investor buys, dealers must hedge by shorting S&P futures contracts. A downside break of 3300 takes gamma below the $1Mn level (bearish). The probability of touching 3300 is currently 81%. The flip point has moved up and lies between 3235-3250. The probability of touching this level is 51%. OTM puts took a hike up in value today. Dark pools remained buyers Thursday, despite elevated valuations.
• Volatility: The consensus is higher volatility in the foreseeable future. There seem to be a lot of reasons for volatility to rise but it’s not yet priced in. We remain near the floor in VIX and vol-of-vol is just beginning to rise. The VIX call buyer, often referred to in the markets as “50 cent” is back.
• Auction Market Process: A buying tail six minutes into the open at 3302. After the World Health Organization said it was “too early” to declare the spread of coronavirus a global emergency, the rebound from Thursday’s selloff was lead by technology, utilities, and real estate.
• Bonds: High yield and junk remains the most dangerous part of the credit market. Treasuries are already in breakout mode. Yields are down over fears of coronavirus contagion and nobody knows how this will turn out. China continues to step up its efforts to contain the disease. (Treasury inflows are generally driven by inflation fears and economic slowdowns.)
• Precious Metals: There are growing shortages of palladium, now the most valuable precious metal on earth. In addition, trading volumes are exceeding physical supplies.
• Macro: Increased numbers of dead and suffering from the coronavirus took markets down in early trading, Thursday, until the World Health Organization chose not to declare a global emergency over the outbreak.
We are currently seeing inflows into secular growth (e.g. technology and consumer staples), defensives (e.g. Treasuries, precious metals, healthcare, and bond proxies (utilities and real estate). Much of the fuel for the rally – namely, central bank liquidity, trade deals, improving economic reports, and chronic short covering are coming to an end.
It is increasingly difficult to be bullish here – easier to be neutral at best. Putting on some tail risk trades, either directly in the volatility ETPs, or by buying some deep OTM short-dated VIX options makes sense. Treasuries will rally in a risk off move and it may be a good time to build a position here. Lastly, one might consider tail risk hedges in either direction as the potential for continuation in this “melt up” rally remains.