Traders pay up for protection against sharp falls in US stocks
Spreading coronavirus and looming presidential election has investors on edge
Traders have been scrambling to protect themselves from a collapse in US stocks, spooked by the coronavirus outbreak, the looming presidential race and the sheer strength of last year’s rally.
The US equity market climbed 29 per cent in 2019 and started this year strongly, but the spreading nervousness has sent the S&P 500 index down by about 2.5 per cent since the middle of the month.
The Cboe Volatility index — known as the market’s “fear gauge” — suggests that traders are now bracing for sharper moves. The 10-day moving average volume of Vix call options — derivatives that allow traders to benefit from a spike in turbulence — has increased from 200,000 traded at the start of January to about 400,000.
The Vix itself has climbed from a low of about 12 points in mid-January to over 18 on Thursday, when the S&P 500 index was off by 0.7 per cent by midday in New York.
There are many negative factors “that are screaming for a big stock sell-off”, said Stephen Aniston, president of vixcontango.com, a volatility trading analytics provider.
Activity in put options linked to the US stock market, which offer investors protection against equities slumping, has also been rising in recent weeks as the spreading coronavirus and the approaching US presidential election has investors on edge.
Trading in S&P 500 put options has climbed to levels not seen since September. The 10-day moving average for put volume on the S&P 500 has gone from 720,000 at the start of January to 920,000, again the highest since October.
Traders said the flurry of hedging activity is similar to October 2018, when Federal Reserve chair Jay Powell’s remarks on interest rate increases and “quantitative tightening” rattled the market, and also in February 2018, when Vix-linked funds hit trouble.
A slide in government bond yields and a rise in gold prices are further signs of investors’ sharpened appetite for safe assets, traders noted. The benchmark 10-year US Treasury yield sank to a four-month low below 1.55 per cent on Thursday, while gold has nudged above $1,580 a troy ounce.
The upcoming US presidential election has also prompted some investors to buy insurance against market declines. Senator Bernie Sanders recently surpassed former US vice-president Joe Biden in a poll on the popular political betting site PredictIt for the first time, just days ahead of the first caucus for the 2020 Democratic presidential nomination.
A Deutsche Bank poll indicated that 90 per cent of clients thought that a victory for Mr Sanders would be negative for the US stock market. The left-leaning US senator from Vermont is now in the lead with a 39 per cent chance of winning the Democratic nomination, according to bets on PredictIt. Data gathered by Real Clear Politics has him ahead in Iowa, which casts the first votes of the 2020 campaign next week.
“The market is going to start to price in some serious probability of a leftwing Democratic win, which will hit stocks quite a bit,” Mr Aniston said.
Investors are also worried that underwhelming corporate profits will unsettle the stock market, given how far and fast it rallied over the past year. “We now see the market fully valued, particularly within US equities. This is not going to persist indefinitely,” warned Erin Browne, a managing director at Pimco.