Podcast Summary
Inverted VIX futures curve signals heightened market uncertainty: Market volatility is high and investors are buying more protection for the present than the future due to uncertainties, including elections.
The current market environment is characterized by heightened volatility and uncertainty, as evidenced by the inverted VIX futures curve, which has been the case for the past six months. This anomaly suggests that investors are paying more for volatility protection in the near term than in the future, reflecting their concerns about the present. The unusual configuration of the VIX curve could be attributed to the extraordinary times we're living in, with various policy and virus-related uncertainties looming large. This situation contrasts with the conventional wisdom that over the long term, markets tend to be less volatile and more predictable. Despite this, many financial products are based on the assumption of an upward-sloping VIX curve. One of the most significant upcoming events that could impact volatility is the US elections, which have already sparked a flurry of volatility hedging activity.
Heavy focus on upcoming catalysts causing downward sloping VIX futures curve: Investors heavily focused on upcoming events, making it difficult for traders to profit from increased volatility as many are already hedged.
The current market environment has led to an unusual downward sloping VIX futures curve, as investors are heavily focused on and hedging against potential volatility events in the near future, such as the election and potential coronavirus resurgence. This demand for hedging has made it difficult for traders to profit from increased volatility, as many investors are already pre-hedged. Chris Sidule, a volatility arbitrage trader at Ambras Group, explained on Odd Lots that when volatility is already priced in, it becomes difficult to make significant gains from market moves. The market's focus on the upcoming catalysts has led to a constant bid for December VIX futures, making it challenging for traders to find added convexity in the market. This trend is not only seen among larger players but also among smaller registered advisers, who are instructing their clients to protect themselves from potential volatility.
Prehedged positions dampen market reactions: The widespread use of hedging strategies is limiting market volatility, making it difficult for the VIX to spike despite ongoing uncertainties. Potential catalysts, like the U.S. elections, may not cause the significant moves some anticipate due to prehedged positions.
The widespread hedging in the market is preventing significant volatility, making it difficult for the VIX (Volatility Index) to spike, despite ongoing fears and uncertainties. The prehedged positions of investors have dampened market reactions to potential catalysts, such as the U.S. elections, and the divergence between VIX and VVIX (VIX Volatility Index) highlights this trend. While there is potential for a fresh catalyst to spark volatility, the market's current prehedged state may not allow for the velocity of moves that some anticipate. It's essential to consider the complexities of the current market situation before making any significant investment decisions.
Navigating 2020's Challenging Market with Relative Value and Sector Strategies: Despite high uncertainty, traders focus on relative value and sector strategies for opportunities, such as undervalued single names vs overvalued sectors or options with high kurtosis.
While the statistics may suggest certain trades based on historical data, such as shorting volatility heading into the election, the high variability and uncertainty of 2020 make it a challenging year for traders to make bold directional bets. Instead, they are looking for opportunities in relative value and sectors, such as earnings expectations and the spread between single names and ETFs. For instance, they may identify undervalued single names in certain sectors compared to overvalued ones, or focus on the wings of options with high kurtosis. These strategies allow traders to express their views without being overly reliant on broad market movements. Principal Asset Management, as a leading real estate manager, offers a 360-degree perspective and expertise across various investment types to help clients uncover opportunities in today's market. Investing always comes with risk, including possible loss of principal. For more information, visit principalam.com.
Election Results Could Bring Significant Disparity in Various Sectors: The US election results could lead to varying outcomes for sectors like oil, healthcare, and energy, with volatility expected to spike. Central banks and market players have contributed to volatility suppression, but the current level is still substantial, leading to an increase in structured products.
This earnings cycle could bring significant disparity in various sectors due to the upcoming US election results. Sectors like oil, health care, and energy could see significant differences depending on the winner. Volatility is expected to spike, and while some may focus on calendar spreads, others may find more opportunities in individual names and sectors. Central banks and market players have contributed to volatility suppression, but the level seen pre-COVID is not present now as some short volatility funds have been impacted. However, the current level of volatility suppression is still substantial, and global low interest rates are pushing new players into the equity market, leading to an increase in structured products.
Millennials' shift towards passive ETFs causing market volatility: Millennials' increased buying power and risk-taking attitude are driving a trend towards passive ETFs, potentially leading to market volatility due to large-scale investment in a limited number of stocks and high demand for derivatives and leverage.
The investment landscape is shifting from traditional methods towards passive, diversified ETF products driven by the millennial generation's increased buying power and willingness to take risks. This trend, fueled by low interest rates and the transfer of wealth, is leading to a potential increase in market volatility due to the large-scale investment in a limited number of stocks. The appetite for derivatives and leverage is also at an all-time high among younger investors. Having worked on the sell side of the desk, I've learned that understanding market positioning and opportunities arising from it is crucial for success. This experience has equipped me with valuable insights to spot potential investment opportunities on the buy side. Additionally, the rise of options trading among younger investors indicates a growing interest in complex financial instruments, adding another layer of volatility to the market.
Excessive gamma hedging can cause market swings: Focusing too much on options rating and dealer risk can lead to excessive gamma hedging, causing more pronounced market swings.
The fixation on options rating and the need for dealers to hedge their risk can lead to excessive gamma hedging, causing more pronounced swings in the market. This was a valuable lesson learned during my experience managing a large book of complex financial products at BMO. An eye-opening moment came when the market was tanking and we were instructed to hedge everything, despite my concerns about the price. This required selling SPX futures and buying SPX calls, driving the market down further. Seeing the market's reaction to our large size and the forced liquidation process made me realize the severity of the situation and the importance of focusing on capturing the left and right tail risks at Amherst.
Expected market volatility and investor risk: As market volatility returns, investors will seek to hedge risk through reducing delta or negative positioning, limiting options for hedging.
Market volatility is expected to return after a period of suppression, leading to increased risk for investors. Complacency will set in, and when it does, short volatility funds and those selling variance will come back into play. The market microstructure is adapting to allow for more frequent and significant moves, and as a leading real estate manager, Principal Asset Management aims to capture these opportunities for their clients. However, when it comes to hedging volatility, options are limited. If you're long, you need to reduce your delta, meaning you'll need to be negative delta. While there may be attempts to be creative or "get out the house" in different ways, ultimately, the end goal is the same: minimize risk. As Chris Cole noted during market downturns, everyone wanted to hedge, and this trend is likely to continue when the market becomes less volatile.
Investing in volatility: protection and profit: Buying options before market volatility increases can protect against losses and potentially generate profits during market downturns, but comes with an opportunity cost.
Investing in volatility, or buying options, can serve as both a protective base and a source of profit during market downturns. However, the best time to make these investments is before market volatility increases, as trying to hedge during market crashes comes with an opportunity cost. The speaker emphasizes that people tend to underestimate the potential severity of market movements and often fail to see the value in paying for protection when markets are calm. Historically, stocks have trended upwards over the long term, but the short term can be unpredictable and volatile. The steep upward slope of volatility curves is due to the uncertainty and difficulty of pricing out the potential severity of market downturns. Despite the cost of buying protection, it can help mitigate significant losses and even lead to profits during market crashes.
Forecasting Volatility: Challenges and Misconceptions: Despite human expertise, accurately predicting market volatility is difficult. Older assets don't necessarily increase in value due to age, and market structure and dealer activities impact volatility expectations. The volatility trading industry's recent growth fuels a cycle of volatility suppression, but long-term stock growth is expected.
Accurately forecasting volatility in the markets is a challenging task for humans despite the presence of intelligent minds in the field. The misconception that older vaulted assets will experience a spike in value due to their age is also debunked, as the market structure and dealer activities have a significant impact on volatility expectations. The recent explosion of volatility trading as an industry has created a self-fueling cycle, where suppression of volatility begets further suppression. However, even though the short term may be unpredictable, long-term expectations suggest that stocks will likely be higher, although the future remains uncertain. The discussion also highlighted the impact of retail traders on market dynamics, with some engaging in call buying and others adopting passive investment strategies. Overall, the volatility space continues to be an intriguing area of study, especially in the context of current market conditions and upcoming events like the election.
Investment industry's view on stocks and volatility: The investment industry believes stocks generally rise, but investors should consider long-term costs and risk tolerance before buying volatility hedges.
Learning from this conversation on the Odd Lots podcast is that the investment industry's view is that stocks generally go up, but investors should ignore short-term noise and pay more for long-term hedges than short-term ones. However, the question remains whether investors really want to take on the long-term volatility exposure and the associated carrying costs. The moral of the conversation is that there will be opportunities to sell cheap volatility exposure in the future, making it an attractive option for long-term hedging needs. But for now, investors should consider their risk tolerance and the potential long-term costs before making a decision. The Odd Lots podcast, hosted by Tracy Alloway and Joe Weisenthal, features insightful discussions on various financial topics. In this episode, they talked about the investment industry's view on stocks and volatility with their guest, Chris Sidille. If you're interested in finance and want to stay informed, be sure to follow Tracy, Joe, and Chris on Twitter, as well as Laura Carlson, the producer, and Francesca Levy, the Bloomberg head of podcasts. And don't forget to check out Bloomberg's new podcast, Money Stuff, where Matt Levine and Katie Greifeld bring the popular Money Stuff newsletter to life every Friday.
