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How Stressed Are Investors Over a Possible U.S. Default?

It depends on where you look. Stocks within 3 percent of all-time highs and gold down 21 percent so far this year suggest there is little stress, while U.S. credit-default swaps tell a different story. They've spiked dramatically in the past several days.

The notion of a U.S. default strikes us as absurd, especially since the government can print money and collects ten times debt service each month (thanks Jim Bianco of Bianco Research for that nugget). Nonetheless, traders make active markets on U.S. CDS, and concern has clearly manifested.

Thirty-day Treasury bill yields also reflect recent stress, spiking to 0.18 percent from 0.01 percent just three weeks ago. I first notedthis flash point on Oct. 2. You might expect investors would rush to short-term paper, but concern about getting paid on time has prompted investors to demand higher return.

Let's acknowledge fixed-income investors are a notoriously worrisome lot. We'd expect concern from them, and we're seeing it. We would also expect concern among options traders, as they increase options prices to reflect greater uncertainty. This would imply a higher Volatility Index (VIX ), and curiously, we're not seeing a spike.

Why not? Call it complacency, or whistling in the dark. Either way, we think change is in the air, and investors looking to capture a rise in volatility have three choices:

I favor choice #3: VXX, the short-term volatility ETN. It trades an average 42M shares/day. I first discussed this "anxiety" proxy on Sept. 24, when it was trading below 14. Today it's about 16.25. Based on its trading this year, it has plenty of room to run, should the belligerence in Washington accelerate.

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