{"id":208191,"date":"2024-06-18T11:15:00","date_gmt":"2024-06-18T15:15:00","guid":{"rendered":"https:\/\/ibkrcampus.com\/?p=208191"},"modified":"2024-07-02T13:30:00","modified_gmt":"2024-07-02T17:30:00","slug":"its-cheap-to-hedge-now-just-saying","status":"publish","type":"post","link":"https:\/\/www.interactivebrokers.com\/campus\/traders-insight\/securities\/options\/its-cheap-to-hedge-now-just-saying\/","title":{"rendered":"It\u2019s Cheap to Hedge Now.\u00a0 Just Saying\u2026"},"content":{"rendered":"\n

Yesterday, we made an assertion that protective puts are relatively cheap right now.  Today we intend to prove it.<\/p>\n\n\n\n

Specifically, we wrote the following<\/a> for those who are concerned that the current momentum-driven rally is getting long in the tooth:<\/p>\n\n\n\n

One strategy involves a barbell \u2013 keep buying the tech-heavy indices but utilizing put options as insurance.  Remember, when we buy insurance, we don\u2019t WANT it to pay off.  And considering that volatility is relatively low right now, the insurance is relatively cheap.<\/em><\/p>\n\n\n\n

An obvious way to back up that assertion is to point out that the Cboe Volatility Index (VIX) is near multi-year lows, as evidenced by the chart below:<\/p>\n\n\n\n

VIX, 10-Years, Monthly Candles<\/em><\/strong><\/h3>\n\n\n\n
\"VIX,<\/figure>\n\n\n\n

Source: Interactive Brokers<\/em><\/p>\n\n\n\n

We see that VIX has not been consistently this low since before 2020\u2019s covid crisis.  Remember that even as the virus was spreading around the world, US markets were slow to react.  On February 14th<\/sup> of that year, when VIX closed at 13.68, we wrote a piece entitled Confessions of a Market Nihilist<\/a>.  The theme was that traders were so enamored of the Federal Reserve\u2019s expanding balance sheet, triggered by a repo funding crisis the prior autumn, that they were willfully blind to the rising risks around them.  Although we are not facing anything close to that sort of existential crisis \u2013 at least not as far as I can see \u2013 I do find the agglomeration of important market divergences<\/a> to be a source of concern.<\/p>\n\n\n\n

And heck, VIX is not in the single digits, as it was before the \u201cVolmageddon\u201d of February 2018\u2026<\/p>\n\n\n\n

But VIX is a bit of a blunt instrument.  Its calculation utilizes<\/a> all S&P 500 (SPX) index options with 23 to 37 days to expiration with non-zero bids.  That means that options above AND below the current market are included.  But when we\u2019re hedging downside, only below-market options are relevant.<\/p>\n\n\n\n

When we look at SPX skews for options expiring in one and three months over the past four weeks, it does appear that at least some options traders are becoming more concerned with hedging the current advance:<\/p>\n\n\n\n

SPX Skews for Options Expiring July 19th<\/sup>, 2024, Today (dark pink), 2-Weeks Ago (lighter pink), 4-Weeks Ago (lightest pink)<\/em><\/strong><\/h3>\n\n\n\n
\"SPX<\/figure>\n\n\n\n

Source: Interactive Brokers<\/em><\/p>\n\n\n\n

SPX Skews for Options Expiring September 19th<\/sup>, 2024, Today (dark orange), 2-Weeks Ago (lighter orange), 4-Weeks Ago (lightest orange)<\/em><\/strong><\/h3>\n\n\n\n
\"SPX<\/figure>\n\n\n\n

Source: Interactive Brokers<\/em><\/p>\n\n\n\n

We can see that implied volatilities across the curves have risen in recent days, but the rise is most pronounced in below market options.  Someone has been bidding for puts.<\/p>\n\n\n\n

That said, when we look at specific options from a moneyness viewpoint, the rise is relatively minor.  Below are charts for 1-month and 3-month SPX options with constant 95% and 90% moneyness (meaning 5% and 10% below the then-current index level).  We chose those levels because they are reasonable ways to hedge a pullback or a correction.  While they could protect against a sharper decline, these are not \u201cdisaster\u201d puts.<\/p>\n\n\n\n

Implied Volatility of 95% Moneyness SPX Options Over the Past Year, 1-Month to Expiration (white), 3-Months to Expiration (blue)<\/em><\/strong><\/h3>\n\n\n\n
\"Implied<\/figure>\n\n\n\n

Source: Bloomberg<\/em><\/p>\n\n\n\n

Implied Volatility of 90% Moneyness SPX Options Over the Past Year, 1-Month to Expiration (white), 3-Months to Expiration (blue)<\/em><\/strong><\/h3>\n\n\n\n
\"Implied<\/figure>\n\n\n\n

Source: Bloomberg<\/em><\/p>\n\n\n\n

While these implied volatilities are off their lows, they are still among the lowest levels we\u2019ve seen over the past year.  When we look over a five-year horizon, we see that these are also among the post-covid lows:<\/p>\n\n\n\n

Implied Volatility of 95% Moneyness SPX Options Over the Past 5-Years, 1-Month to Expiration (white), 3-Months to Expiration (blue)<\/em><\/strong><\/h3>\n\n\n\n
\"Implied<\/figure>\n\n\n\n

Source: Bloomberg<\/em><\/p>\n\n\n\n

Implied Volatility of 90% Moneyness SPX Options Over the Past 5-Years, 1-Month to Expiration (white), 3-Months to Expiration (blue)<\/em><\/strong><\/h3>\n\n\n\n
\"Implied<\/figure>\n\n\n\n

Source: Bloomberg<\/em><\/p>\n\n\n\n

Hedge the current rally if you\u2019d like.  Or not.  It\u2019s up to you.  But if you do choose to hedge, it\u2019s clearly not a historically expensive time to do so.<\/p>\n","protected":false},"excerpt":{"rendered":"

Yesterday, we made an assertion that protective puts are relatively cheap right now. 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