Hedging against falls in US stocks gets cheaper

The cost of protection against falls in US equities is at a one-year low as corporate earnings beat expectations.

The cost of hedging against equities fell to a one-year low last month, Credit Suisse said in a note on Monday.

In other words, an investor who wants to buy a put option on the S&P 500 — a bet that would only pay off if the index fell below a certain price by the option’s expiration — is now paying less to do so than he or she was every month since last July. The cost of a put option expiring in three months is hovering around 1.3 per cent of the S&P 500’s spot price, versus around 2.5 per cent in June, when the UK voted to leave the European Union, and around 3.3 per cent in January, when the market sold off.

Part of the reason why is that corporate earnings have generally come in better than expected, and emerging markets have continued a rally. Those two factors have not only helped stocks advance, but also pushed the CBOE Volatility Index, an S&P 500 option whose price tends to rise when investors anticipate a pick-up in stock swings, to its lowest level in a year.

“This is telling you that options investors aren’t seeing any macro risks in the market,” said Mandy Xu, an equities derivatives strategist at Credit Suisse. “It’s a very constructive market for equities.”

Of course, some investors may see all the calm as a sign of trouble. Markets have been quiet as of late, with the S&P 500 trading in its narrowest range in years and the volatility index, or VIX, hovering around 12.24 on Monday morning. The last time it cost this little to hedge against stocks was shortly before the August 2015 sell-off, which was spurred by fears over global economic growth slowing.

Concerns that the market has become “more vulnerable to growth and policy disappoints” led Goldman Sachs Group on Monday to drop its rating on US stocks to “underweight” for the next three months.

One thing’s for sure: the fear hasn’t caught on in the options market yet.

Dow Jones