Hedging The Coming US Debtapalooza

Tyler Durden's picture

Via Jefferies,

One of the largest potential volatility events for the equity markets this year will be the Q1 US Debtapalooza.  There are three main issues that are to be debated with a crescendo coming in late February – the Long Term Budget Deal, the 2013 Budget Deal and the Debt Limit.  There will obviously be many consequential threats and theatrics associated with these events – including potential threats for government shutdowns and debt defaults – while the very real consequences could be additional US ratings downgrades.  It is important to remember that outside of the 2008 shock, the Debt Ceiling Debate and consequent US Debt Downgrade in Summer 2011 created the biggest volatility event of the past two decades.


Volatility metrics show that the market is extremely complacent heading into these events.   Equity volatility and skew are trading near multi-year lows (5th percentile or less over past two years), while many market indices are making new multi-year highs.  From a positioning standpoint, net exposures are higher than any time in 2012 while hedges are at multi-year lows.  Total SPX Put Open Interest has fallen from 9.5mm contracts to 5.7mm contracts in the past month – This is the lowest level of puts outstanding for the S&P500 since June 2009.  The bottom-line is that we are heading into a potential multiple-standard deviation volatility event with the price of options at their lows and market exposures/equity prices at their highs.

Below, we look at 3Q11 changes in price, front month put implied volatility, and 90-day realized volatility across asset classes to assess the best hedge for the upcoming debt ceiling debate.  We highlight some of our favorites – IWM puts, VIX call spreads and HYG puts – but lay out the full list below.

1)      IWM Puts --  Beta underperforms when the market gets volatile.  Summer 2011 saw IWM fall 22% vs the SPY falling 14%. However, the current volatility premium of IWM over SPY is only 3 vol points – which means you can get IWM beta on the cheap.   Currently IWM is trading on a 17 vol – in 3Q11 it rallied from 20 vol to 49 vol.  This means you not only won on deltas, but you had a vol explosion.  IWM March 82 puts for $1.30.

2)      VIX Call Spreads – Given its convexity, VIX knocks the competition out of the water when it comes to panic moves in the market.  VIX rose 160% during 3Q11.  VIX volatility is now trading at two year lows, which makes upside call spreads look interesting.  This could also be a good play on a run-up in volatility ahead of sequester/budget talks – similar to what took place at the end of the year ahead of the fiscal cliff.  VIX March 20-30 Call Spread for $1.30.

3)      HYG Puts – The High Yield ETFs have seen one of the largest price appreciations/inflows since Summer 2011 (+15% in that time).  The average junk yield is now below 6% and the space seems crowded and susceptible.  HYG protection has fallen dramatically-- Put Open Interest fell from 270k contracts to 150k contracts in the past month as almost all fund protection was centered in December 2012.  HYG options are trading on a 6 volatility –implied vol got to over 18 and HYG fell 8% in 3Q11.  HYG March 92 Puts cost $1.05 – a 3% break-even.

3Q11 changes in price, front month put implied volatility, and 90-day realized volatility across asset classes


S&P 500 Realized 15-Day Vol - August 2011 was a massive event...


Charts: Jefferies and Bloomberg

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savagegoose's picture

so what to i buy  to clean up on this?

Cdad's picture

I think you meant "what to sell?"  This morning would be a good time for the market to become concerned about what President Zero is about to say in his State of the Union speech.


AccreditedEYE's picture

You buy the dip.... the very fact this report is being put out ensures that a massive amount of protection will be bought, risk assets rip higher and this protection expires worthless putting lots of income into the sell side banks that recommended it. If the past month and a half have taught us anything, it's that the market only goes in 1 direction: UP! (Gold looking like a good bargain here too)

StandardDeviant's picture

Um, I know no one really reads the articles any more, but he did spoon-feed you three trades:

1) IWM March 82 puts for $1.30

2) VIX March 20-30 Call Spread for $1.30

3) HYG March 92 Puts for $1.05

Don't know when he wrote this, but IWM, for instance, is up to 91.13 at the moment, so your $1.30 will do even better, buying you 90 or 91 puts rather than 82.  Similarly, you can get HYG 93s for 0.83 or so, rather than 92s for 1.05.

Are any of them a good idea?  Who knows, but vol is low, so it's a cheap punt.  Buy me a pint if it works out for ya.

GetZeeGold's picture



We don't have a debt problem - Nancy freakin Pelosi


She's a super freak.....she's super freaky. Don't get me started on Newt.

new game's picture

i think it is called, as that west coast talk dude wrote, "the enemy within"...

tango's picture

S&P is probably chomping at the bit to issue a downgrade and PROVE they are now on top of things (lol).  The idea of the bankrupt US government lecturing anyone on fiscal responsibiity is pitiful and hilarious.  Another downgrade causes more nations to start thinking of an alternative to dollars.  No, there will be no collapse or mad rush to sell dollars but it is another loose stone rolling down the hill. 

Renewable Life's picture

LOL, Let me get this straight, these cocksuckers "suspend" the debt ceiling last month and you think they are EVER going to to reinstate it!

Fucking GOP morons, outsmarted again! Obama wants unlimited spending, taxation, and debt BUT so do those fucking GOP cocksuckers, they just have this little "getting elected" problem that the DEM's don't!

At every fucking step, Obama gets what he wants in the can kicking and the GOP gets their cans kicked, it really is unfucking believable!!

I see no evidence, that this Feb/March "debt debate" will be any different!


Lol if the market pulls back even five% off the highs ill eat my aapl 650 puts

Middle_Finger_Market's picture

Debates should be written ''debates''. It is all an illusion to entertain the masses; worship the state, we are your masters and rulers.

TheInfoman's picture

 "Volatility metrics show that the market is extremely complacent heading into these events."

The markets have been rope-a-doped.

new game's picture

sheer the sheep, silence the lambs

then some brain salid surgey

all good, buy til hearts content...

dopimine rush, b/4 buyers remorse...

still fighten the fed?

Super Broccoli's picture

what market ? the bank's algos ?

youngman's picture

I was just thinking if I was a foreign country watching this.....I would change my way of doing business....kind of like an uncle that always borrows money and never repays it....so you might not lend him anymore...only cash up front deals....so if you want to deal with Japan, Europe, The USA....you will sell them your junk...but you want cash right away...no more credit

fonzannoon's picture

This article is hilarious. The best part is about the possible debt downgrades.....from who? Moody's? I think they got the message. Egan? S&P?


SheepDog-One's picture

And the last time we got a 'dreaded debt downgrade', the markets gained 35% since then? O NOEZ!

Bob's picture

Agreed, that was hilarious. 

buzzsaw99's picture

so lever long with no (zero) hedge then?

Dr. Engali's picture

"There are three main issues that are to be debated with a crescendo coming in late February – the Long Term Budget Deal, the 2013 Budget Deal and the Debt Limit".


By debated he really meant to say " politicians will trot their ugly asses out on tv and get their moment in the sun tthen they will promptly kick the can again"

fonzannoon's picture

It's amazing isn't it Doc? There are still news organizations that would have you believe that budgets and deficits could actually be a point of contention that could rile the markets. Funny I see even CNBS gave upo on their "rise above" stupid fkin pins. It's over. Now we just sit here in cruise control with no brakes. Turn the music up if you don't mind.

francis_sawyer's picture

Valentines Day isn't until Thursday...

fonzannoon's picture

what are you getting your jewish friends?

Dr. Engali's picture

Fonz you have a little devilish streak in you, stiring the pot ;->

fonzannoon's picture

I like Francis. I was assuming he was busting my balls and figured he is a big boy and can take a joke as well.

francis_sawyer's picture

I can take a joke... Glad to see you can too...


Nobody is getting any Valentines Day gift from me... Somehow ~ I woke up and found out all my fiats were stolen... Gold doesn't count because 'it's not money' & besides, it's at the bottom of the lake...

Colonel Klink's picture

I wasn't quite sure about you Francis but I'm starting to warm up to you a bit.  You joo hating bastid! ;o)

Dr. Engali's picture

What is even more amazing to me is that people actually believe it still. It literally makes me want to explode when I hear people say something like.." well if only such and such was in charge". To me it's just unbelievable that people are that stupid wilth the amount of information we have at our fingertips. But then again there's Honey Bob Boo...

Tsar Pointless's picture

I'll snowball on top of that "when they vote on so-called legislation that is written by the corporations and for the corporations who truly run this dump we call the United States of Amerikkka."

Nid's picture

So Jeffries is now pitching VIX calls? Without any mention of the Fed sponsored VIX decimation which goes on daily?

Meanwhile, Eq Futures continue their morning ramp....carry on.

MFLTucson's picture


Enough with the drama! 


Inthemix96's picture

What with what the world has to worry about at the moment its a good job we still have firms like Alderley Systems here in good old Blighty.

They have decided that all the staff who drive have to now park facing the same way for health and saftey issues.  On what grounds who the fuck would know?

And we are not fucked?  Fucking imbeciles.

Ralph Spoilsport's picture

I'd expect decisions like that from a company based in Wotton-under-edge. Edge of what?

Inthemix96's picture

You want to try my job mate.  I am a self-employed employer who cleans windows.

Visual Technician, and we do work for local authorities up north here.  You would not believe the shit we put up with, and what we have to do just to clean fucking glass.

The whole world is fucked, and getting fucking insane by the day.???????

onelight's picture

I like that, "Visual Technician" term for a window cleaner :)

A friend in the window cleaning business once described his work (on the big panes) as "Irish Tai Chi" -- great.

I was a window cleaner for 7 years, paying for college at Berkeley etc. - we had truck, ladders, uniforms, yellow page ads and corporate clients (HP's HQ, Consol Freightways) and a good team of professionals. Long hours and a lot of hard work; eventually I had to quit to go to school, could not do both.

Can appreciate the challenge of the "self-employed employer who cleans windows"

It's 30 years later for me, and must be harder now, so all the best to you and good luck.

Super Broccoli's picture

hey the debt ceiling !!! long time ! 16,5 T debt so far, what's the new limit they did set up in january ?

SheepDog-One's picture

I see, so 'debt' is only a problem on days when it's declared an 'event'? This is all just silly, as they ramp markets to all-time record highs.

fonzannoon's picture

Sheep the plan is to keep this market together until the 2016 election. But once it's over it is going to crash hard.

SheepDog-One's picture

OH I see...it's 'all for the elections' again!

semperfi's picture

All Western markets are now centrally coordinated for the benefit of the global elite bankers.  All discussion about the market from "economists", govt-types, MSM, etc, is now just propaganda to support the central plan.  It will be the rising Eastern bloc that breaks this monopoly.  So do we 'cheer on' the Eastern bloc ? 

espirit's picture

Is this article market based on technicals?

My hedge is on smoke and mirrors, and debt doesn't matter until it does.

Old, tiresome, and wornout BS.

new game's picture

last i checked gravity was still an ever present danger...

Peter Pan's picture

You cannot resuscitate a dead horse but unfortunately this is what they are trying because it's just too hard to admit to the death of the horse. To top it all off no one wants to make the effort of dragging the dead animal out of the barn. Instead we keep giving it mouth to mouth through various means and ignore the stench and the germs that then proceed to engulf the whole barn.

In the end we will be forced to burn the whole barn down through war because everything else is too complicated and furthermore no one wants to pay for his or her share of the blame.

TrustWho's picture

We have Daddy Bernanke. He is a good Daddy. If his children look a little sad or slightly uncomfortable, he buys billions with his magic to keep a smile on their face. His children are rotten to their souls.

semperfi's picture

"Volatility metrics show that the market is extremely complacent heading into these events."

As well it should be.  Remember the Bernanke Put?  Its good until the masses are wearing the WIP t-shirts (Wip Inflation Now - I still have one of those old 70's buttons)

DOT's picture

OT (at least somewhat).

The love of my life came in last night and wanted to talk about "allocation".

This is the most BEARISH thing that has happened anywhere in the last 12 mos.

It seems that some of the taxpayers out there actually notice the reduction in net pay.

They may see the "increase" in the AMaZiNg market as an opportunity to fix their retirement plan.

So, what will it be this year? Spend that Tax Refund, or stick it into the market?

gmak's picture

Editor: Where are you.


It's IWM Mar 90 puts for 1.30


The P-82 are $0.16 / $0.17


NEOSERF's picture

S&P lawsuit was just a warning not to start talking downgrades again after this epic can-kicking tax and spend effort coming up in the next 2 weeks.

Shoofly7's picture

Mi scusi, ma il March 20/30 VIX call spread is .35.   ¿De dónde sacaste $1.05? Merci, I'm sure 

StandardDeviant's picture

Yeah, the advice is just a bit out of date.  Options move fast...