Investors pile into insurance against further market sell-offs

Investors are buying record-high insurance contracts to protect against a sell-off that has already cost trillions of dollars in US stocks.

Purchases of put option contracts on stocks and exchange-traded funds have skyrocketed, with big-money managers spending $34.3 billion on the options in the four weeks ended Sept. 23, according to data analyzed by Sundial Capital Research Options Clearing Corp. The total was the largest on record since 2009 and four times the average since early 2020.

In the past week alone, institutional investors spent $9.6 billion. The waste underscores the extent to which big funds are trying to protect themselves from a nine-month sell-off that has been fueled by central bankers around the world who are aggressively raising interest rates to curb high inflation.

“Investors have recognized that [US] The Federal Reserve is very politically constrained where it is by inflation, and it can no longer be relied upon to manage asset price volatility risk, so it must take more direct action itself,” said Dave Jilek, chief investment strategist at Gateway Investment Advisors.

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Jason Goepfert, who leads research at Sundial, found that the volume of stock put option purchases, adjusted for US stock market growth over the past two decades, was roughly equivalent to the level seen during the financial crisis . In contrast, demand for call options, which can pay off when stocks rally, has waned.

Line chart of premiums spent to initiate new put option contracts after 4 weeks ($bn), showing big money managers hedging while the market slides

While the sell-off has wiped out the benchmark S&P 500 stock index by more than 22 percent this year and pushed it into a bear market, the slide has been relatively controlled and lasted months, not weeks. That has frustrated many investors who have hedged with put option contracts or bet on a rise in Cboe’s Vix volatility index but have found the protection did not act as an intended shock absorber.

Earlier this month, the S&P 500 experienced its biggest sell-off in more than two years, but the Vix failed to break through 30, a phenomenon never seen before, according to Greg Boutle, a strategist at BNP Paribas. In general, large drawdowns push the Vix well above this level, he added.

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Over the past month, money managers have instead turned to buying put contracts on individual stocks, betting that they can better protect their portfolios by hedging against large price moves at companies like FedEx or Ford, which have plummeted after profit warnings.

“You saw this extreme contortion. It’s very rare to see this dynamic where put premiums in individual stocks are bid so high relative to the index,” said Brian Bost, co-head of equity derivatives Americas at Barclays. “This is a major structural change that doesn’t happen every day.”

Investors and strategists have argued that the slow decline in major indices is partly due to investors largely hedging after falls earlier this year. Long-short equity hedge funds have also largely scaled back bets after a dismal start to the year, meaning many large positions have not had to liquidate.

Line chart of short-term volatility deviation showing that demand has shifted towards hedging dips in individual stocks

As stocks fell again on Friday and more than 2,600 companies hit fresh 52-week lows this week, Cantor Fitzgerald said his clients were taking profits on hedging and entering new trades with lower strike prices while they wrote new insurance.

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Wall Street strategists have trimmed year-end forecasts as they factor in tighter Fed policy and an economic slowdown that they warn will soon begin to hurt corporate earnings. Goldman Sachs lowered its S&P 500 forecast on Friday, expecting the benchmark to fall further as it dumped its bets on a year-end rally.

“The forward paths of inflation, economic growth, interest rates, earnings and valuations are all more fluid than usual,” said David Kostin, strategist at Goldman. “Based on our client conversations, a majority of equity investors believe a hard landing scenario is inevitable.”

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