These Are The Cheapest "Market Shock" Hedges Right Now

With the "smart" money (as defined by Don Hays) exiting the stock market in droves, yield curves collapsing (now with extra help from a "Twisting" ECB), extreme speculative positioning in bonds, and a dramatically diverging economic reality from market market narratives, the possibility of a crash - Fed triggered or not - is rising. Do 'they' know something the "dumb money" does not?

And with everyone still the same side of the rates boat...

... while Bank of America is warning that the current market feels ominously similar to that right before the 1998 Asia Crisis and LTCM blow up...

... the question is - what's the cheapest way to hedge against a crash scenario?

Bank of America's Jason Galazidis has some answers for traders looking for some protection. The screen below shows that the hedges, ranked by the average, which are most underpricing historical drawdowns are Gold calls, EUR 10y receivers and TLT (US 20y+ Treasury) calls:

EUR 10y receivers and TLT calls screen as the best value hedges after Gold calls. Interestingly, USD 10y receivers screen materially richer owing to increased demand on heightened US trade tensions.

HSCEI puts are the second best screening equity hedge after RDXUSD (Russia) puts despite the HSCEI being the worst performing equity index in our screen (YTD peak vs. current levels).

EU Credit payers have richened remarkably over the last few months, particularly in IG, following the extreme widening in EU-periphery bond spreads in May. Our credit derivatives strategists note that the richening of downside tails in credit (payer skew) reached 8y extremes driven by heavy hedging demand.

As a reference, the table below shows the largest drops (or gains in the case of GLD, gold, Euro and US 10Y and TLT as designated with **) within 3 month in each asset class between ‘06 and ‘17, ranked in the same order as the assets in the chart above. The table shows that gold not only has a high vol delta but is consistently one of the best performing assets during crisis times.

And so - once again - the precious metal regains 'most-favored-nation' status as the world's emerging markets collapse and economic reality washes ashore on the banks of the river-of-excess-debt.

Since the middle of January, gold's implied vol has been notably, systemically lower than stocks:

And US equity vol has "normalized", catching back up to Europe over the past month:

Cross asset risk is once more in benign territory relative to history as vols and credit spreads are all in their 1st quartile, although recently cross asset risk rose across the board led by credit spreads, while commodity volatility has emerged as a notable exception after declining MoM - largely thanks to the recent surge in the price of oil - and is now the 2nd least elevated risk metric vs. its own history.

Meanwhile, another indicator that further vol breakouts are coming is the 12M cross-asset-class correlation, which has continued its climb since the Feb-18 equity-led sell-off, and is now at 5y highs.

Historically there have been 3 distinct cross asset correlation regimes since 1995. Interestingly, we see a broadly upward trend since Oct-03, well before the Lehman bankruptcy in Sep-08. This is related to the liquidity driven crush in asset risk-premia that helped drive investment leverage higher.  Long-term correlation established a new regime since 3Q13, similar to the ’03 to ‘08 correlation environment.

Which brings us to the punchline chart: these are the two-month-forward historical stress peaks observed during turbulent market shocks in 2008, 2009 and 2011, and compared to current levels. This is BofA's way of hinting where vol is most underpriced assuming, of course, that a crash should occur in 2 months:

The chart illustrates why it is useful to consider the relative pricing of options across asset classes to hedge against tail events: option markets often underestimate the severity of market shocks, and to different degrees. In 2008, currency, equity and sovereign risk vols were the most optimistic ahead of the Lehman crisis and the most surprised after (rose to the highest levels).


the crow Joe Trader Sun, 07/01/2018 - 08:58 Permalink

Here is why thats a bad you are buying front month otm puts? will need to spend 1000 a month  on a 1% chance....even large spy or qqq moves will not increase delta ....better to buy 3 month vix 24 calls for 0.50...if the market breaks the vol will explode...yiu can get 5 to 10 10 to 20 times ur money....dont buy 40 or higher vix takers even if ur right.

In reply to by Joe Trader

Automatic Choke Sat, 06/30/2018 - 18:42 Permalink

I wonder where real estate sits in this chart?

(Yes, there are vast differences in real estate....overpriced shack/condo in silicon valley, farmland in kansas, malls in toledo.  I'm thinking of solid underpriced real estate, such as mid-range single-family home in mid-west college town that hasn't boomed yet... which I consider to be pretty recession proof.)



EuroPox Sat, 06/30/2018 - 18:44 Permalink

The Asia Crisis and LTCM blow up?? That was back in the day when there was still a market!  How much cash has been printed since then?  How many bubbles have been blown?

It was Greenspan 'opening the taps' after LTCM that started it all - why would they let things crash when all they have to do is print some more?  This goes on until the world stops using fiat.

Real money, a gold-backed currency gaining widespread use, is what will kill it.

tribune Sat, 06/30/2018 - 19:00 Permalink

deep down I'm a gold bug, but i thought that Elliot wave international has shown that gold has gone down during just about every us recession. it went down in 2001. it went down in 2008

wonger Sat, 06/30/2018 - 19:50 Permalink

tribune, gold was in an uptrend before 2001 & 2008, its been in a downtrend since 2011, its possible that it doesnt sell off this time and just rallies, it needs careful consideration, i now have all the physical gold and silver i want purchased in the last week, im fully hedged to the downside with futures and options, but im prepared to remove these at a moments notice if things start to smell different this time, we need to be very careful here, very interesting times indeed

tribune wonger Sat, 06/30/2018 - 20:19 Permalink

i believe in gold myself because this time the money system may be changing. i'm just not hanging onto the belief that gold is going up in nominal terms during the next downturn. remember if is gold is such a good barometer of inflation, axiomatically it must be a good barometer of deflation as well. it is also very liquid and may as well as being sought as a safe haven , it will also be used as a liquid asset when people want to liquidate their debts, thanks for your comments

In reply to by wonger

shizzledizzle Sat, 06/30/2018 - 20:42 Permalink

What no HYG puts? look at the open interest and consider where those high yield bonds likely reside... Not saying to go all in but if things do go to shit... I know, I know... Bond holders are always made whole. But we are talking about hedging here.

Yen Cross Sun, 07/01/2018 - 04:14 Permalink

 Before looking, is there Vol derivatives for P/M's other than direct put and calls?

  The gold and silver is being stupidly manipulated by hedgers vs specs.

  Very massively long on the spec side. Maybe a gold/chf or jpy hedge. The yen looks pretty idiotic right now.

  I'll do some yen chf vs gold correlation overlays.

El Hosel Sun, 07/01/2018 - 08:53 Permalink

"How to measure Gold value historically", using price, when the price is systematically suppressed by order of Policy...

Or, how to hedge investments in a "Market" that has no correlation to fundamentals or supply and demand.

Welcome to Dirtyfuckerville, have a nice day.