Hedges Triggered in U.S. Stocks as Puts Explode, VIX Takes Dive

  • VIX tumbles 8.4 percent after spiking 49 percent on Friday
  • Volume on VIX futures surged in the days leading up to Brexit

Say what you want about U.S. equity investors after the U.K. vote on the European Union. Just don’t say they were unprepared.

The precautions taken by traders to hedge against Brexit are playing out in today’s market, where options-derived measurements of market stress are actually falling despite a second day of weakening stocks.

While the S&P 500 Index extended its post-Brexit loss with a 2 percent decline at 2:49 p.m. on Monday, the CBOE Volatility Index fell 8.4 percent, marking the first time since 2008 the two have simultaneously declined to such a degree. The rare concerted move is a sign to analysts that investors are getting out of hedges they bought as VIX futures volume surged 40 percent in the four days leading up to the U.K. referendum.

With the S&P 500 seeing tempered selling after its biggest loss in 10 months on Friday, investors are feeling comfortable enough to exit hedges, according to Dan Deming of KKM Financial LLC. The biggest exchange-traded fund tracking the index has seen volume of bearish options jump over the last two sessions as traders look to take profits on hedged positions and sell contracts to other investors seeking protection.

“You can certainly make the case that investors were bracing for this, with all the hedging taking place,” Deming, a Chicago-based manager at KKM Financial, said by phone. “Now you’re seeing an unwind because there hasn’t been a massive downward follow-through in the S&P.”

The S&P 500 slid to 1,995.80 on Monday, extending its two-day decline following Brexit to 5.6 percent. The VIX lost 8.4 percent to 23.59, after surging 49 percent Friday. It’s the first time in almost eight years and just the second day in history that the benchmark equity gauge fell 1.5 percent while the VIX lost more than 5 percent, Bloomberg data show. The two gauges have moved inversely to each other 82 percent of the time the past decade.

“Historically we’ve seen political events get priced out of the market fairly quickly afterwards,” said Deming. “That’s being factored into the decision of how much volatility investors want to own at this point.”

A spread monitored by options traders to track demand for protective hedges -- implied versus realized volatility on the S&P 500 -- widened to a record in the days leading up to the Brexit referendum, even as shares powered higher.

Investors should remain aware of how quickly the VIX can change directions, said Deming. The CBOE VVIX Index, which measures implied volatility on the fear gauge itself, sits about 25 percent above its 2016 average.

The drop in the VIX doesn’t necessarily mean a retreat in perceived risk, according to Jim Strugger, a derivatives strategist at MKM Partners in Stamford, Connecticut. In fact, the futures curve on VIX contracts, which tracks expectations on how volatility will move over time, is little changed from Friday, he said.

The VIX closed above 25 on Friday for the first time since February, when the S&P 500 was about 8 percent lower than its current level. Heading into the Brexit vote, the net long position held by asset managers was close to the largest since at least 2010, according to Macro Risk Advisors. The firm also sees traders closing those positions.

“Anecdotally, much of the flow on our desk was clients unwinding or adjusting hedges,” Pravit Chintawongvanich, head derivatives strategist at MRA, wrote in a client note on Monday. “We think the initial move may have been muted due to investors being fairly well-hedged going in.”

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