Hedges Are "Pricing A World Almost Free Of Risk" Says BofA: Here's How To Trade It

Tyler Durden's picture

Over the weekend, Bank of America's volatility experts Jason Galazidis and his team, pointed out that while US equity vol remains at historic low levels, it is not just equities where market participants are remarkably complacent, and write that both US credit & Chinese equity hedges "are pricing a world almost free of risk."

To Galazidis this is perplexing  as "there appear to be abundant potential sources of global market uncertainty: a CB policy miscalculation, the propensity for political surprises, unanticipated consequences of the first US rate hike cycle in over a decade and the feasibility of Trump’s economic growth agenda, to name a few."

And as Goldman pointed out recently when it demonstrated that the cost of liquid long-dated hedges in equity and credit has collectively reached its lowest level in six years...


... BofA agrees that risky assets for the most part remain euphoric, exhibiting what the bank's Michael Hartnett has famously termed an "Icarus" moment before "hubristic positioning, complacent profit expectations, and hawkish policy signal a reflection point."

Notably, Galazidis adds, cross-asset vols (baring a few isolated assets such GBP and JPY) have declined to  very low levels (Table 1 and Table 2) making select hedges relatively cheap to own.

How to capitalize on this? Simple: buy those puts which are pricing in a world of "absolute perfection" and no uncertainty as far as the eye can see. BofA has the following suggestions on how to identify  value in puts across asset classes

Chart 1 shows crash returns of different assets during historical tail events per unit of current OTM option implied volatility. We measure tail events by the 10 largest 3M drops since Jan-06. Ranked by the average, the screen shows that the hedges which are most underpricing historical drawdowns are: US (IG & HY) Credit payers, GLD (Gold ETF) calls and HSCEI (Chinese equity) puts:

  • US (IG & HY) Credit payers – which we are reintroducing to our universe of assets - screen as the best value hedges across asset classes owing to historically low credit volatility (Chart 2). European credit and HYG (US HY Credit ETF) puts also screen high, ranking immediately after Asian equity puts.
  • GLD calls are the 3rd top ranking hedge as current options costs are discounting the historical propensity for Gold to rally strongly during risk-off episodes.
  • HSCEI puts continue to screen as best value within equities. In contrast, ESTX50 puts are near the bottom of our screen (most expensive) as 3M option prices now embed French election risk premium (voting takes place on 23-Apr and 7-May).

And, as a reference, the following table shows the largest drops within 3M in each asset class between ‘06 and ‘16, ranked in the same order as the assets in Chart 1. For those who believe that the period of low volatility is ending, this is the best reference to find the derivatives that are "coiled" the most.

Who knows: maybe this time those willing to fight the central banks, and betting on a rebound on volatility, will finally be right.

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Last of the Middle Class's picture

The thing about forming up enough derivatives to completely do away with any risk at all is that you end up destroying the economy you were building the derivative on in the first damn place. Jeez.

Escrava Isaura's picture

"Pricing A World Almost Free Of Risk"

Exactly. Because capitalism is almost over. So the stock market will not even pretend that there’s free market out there, because they will be the last one stand.

By the way, what happened to “Make it great again?”

“America’s elites know that capitalism is totally unworkable. We try to impose it in the 3rd world so we can destroy them” — Noam Chomsky


flicker life's picture
flicker life (not verified) Escrava Isaura Mar 12, 2017 6:33 PM

I'm making over $7k a month working part time. I kept hearing other people tell me how much money they can make online so I decided to look into it. Well, it was all true and has totally changed my life. This is what I do... http://bit.ly/2jdTzrM

hotrod's picture

Aint no fucking risks anymore.  What happened to all the OIL derivatives when it crashed?  What happened to all the commodity derivatives when they crashed? Glencore was supposedly going to bring the house down, Douche Bank suppose to start the financial chain reaction. Nothing Nothing Nothing.  Paper over it all until adjustments are made or prices stabilize and come back.  Just like a bank holding onto all those REOs until the housing market was brought back.  With unlimited money and the electronic collusion between all Central Banks in the USD basket false realities can continue. If you can get countries like Ireland and Belgium to suck up Billions of Treasurys, worth more than their GDP then imagine what financial magic is available.

HRH Feant's picture
HRH Feant (not verified) Mar 12, 2017 5:27 PM

No risk? WTF are they smoking at BOA? That must be some good shit because they are clearly on the verge of psychosis.

Herdee's picture

Like I said before, the Fed is manipulating all markets on their huge trading desk. It depends on whether or not they can keep manipulating. They can't do it forever and the market is a lot bigger than them. Could be a bloodbath one day when the Fed can't win out.

LA_Goldbug's picture

Hence we the little fucks will not trade shit, Why? Because we now know it is all Bullshit.

Jungle Jim's picture

Well, silver is pretty risky. Gold too. Look what happened to both in the past week or two.

fbazzrea's picture

depends whether you're trading or investing. short or long. 

long-term investors have enjoyed the discounts. 

and as far as overall risk: LOWEST 

Jungle Jim's picture

I *thought* I was investing in silver and gold when I bought 1648-point-something troy ounces of silver and 51-point-something troy ounces of gold in 2010-2011. I was expecting some return on my investment. Or, at least, that silver wouldn't lose over two-thirds of its market value and gold nearly half of its market value.

Starting in 2013 I had to start selling off my metal. Everything else of value that was not needed for immediate survival had already been sold. There was nothing else to sell.  

I sold ALL 1648 ounces of silver, sometimes just a couple of Eagles at a time, sometimes a tube of them, sometimes more than one tub. Now I have *zero* silver. Not so much as one Mercury dime now.

When the silver ran out I had to start selling the gold. I've gone from 51 troy ounces to six, and an ounce must be sold within the next few days, at this price, if I am to pay the rent and keep the lights and the heat on, and the phone connected. I have zero other income of any kind.

Basically I got slaughtered, and am now possibly or probably facing homlessness.

Amy G. Dala's picture

Jim, the textbook definition of an investment is:  My money goes into some dark hole, and someday with sone luck I can get it back again.

Trading is different.  An investment is essentially a trade gone bad.  So anytime you hear the word "investment", especially if it is in the public realm, as in "we need to invest in our kids" or "we need to invest in our future", hang onto your wallet. 

Investing is for dummies.

Okienomics's picture

SPY Put with Strike Value $234 expiring 12/15/17.  SPY at $237 on Friday.  The put is trading at $10.95.  It will be in the money with a 1.3% drop will have paid for itself with a 6% drop, NOT EVEN COUNTING THE REMAINING TIME VALUE OF THE PUT OPTION.

That is an underpriced asset my friends.  I'm long that as well as SPY Put, Strike $237 expiring 12/15/17.  

Of course, I'm playing with money I can afford to lose.   But damn.

Amy G. Dala's picture

Ha ha, time value.  What is the 15th, wednesday?  Earl, have you been drinking?

Amy G. Dala's picture

     "Well, I'm not going to spend it on futures and options."


      Liam Neeson, when asked by the chair of Barrons how he planned on spending his performance bonus.