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Finally, I have some exciting stock market news to talk about… wait, never mind. It’s been yet another uneventful week for stocks. In fact, the stock market has been so boring lately, the boringness itself has become news.
Historically low volatility in the market means there has been very little day to day action. We’ll occasionally get a single stock to move based on stock-specific news, but the overall market is rarely doing anything to get excited about. There’s been so little action that investors and analysts are starting to worry about getting blindsided.
There is real concern beginning to crop up at investment conferences and online discussions about why market volatility has been at historic lows despite a fair amount of political turmoil. You’d think the current state of the US government would lead to at least a little concern among stock buyers.
Alas, the VIX – the S&P 500 implied volatility index – has been sitting at ultra-low levels for most of the year, outside of a few minor and very short-lived spikes. Keep in mind, implied volatility is a measure of what investors think is going to happen. So, investors and traders simply are not expecting an increase in short-term volatility, at least on the surface.
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And yet, historical volatility for the S&P 500 – what has actually happened in the index – has been even lower than what the VIX is predicting. In other words, as low as the VIX has been, it actually hasn’t been low enough to match what’s really happened.
So what gives?
There are several theories floating around as to why realized market volatility has stayed so low. At least part of it is due to expected consequences. That is, even if major scandals cause changes to occur in the US administration, it likely won’t have much fallout related to businesses. It’s not like a US political scandal is going to lead directly to a higher corporate tax rate or sharply higher interest rates.
Another theory I’ve seen is that while investors and traders aren’t buying a bunch of expensive options as hedging instruments, sales of deep out-of-the-money S&P 500 puts have still been brisk. That is, ultra-cheap puts are still selling well. These are the type of options which would only pay off in the event of a black swan event (massive selloff). These options also wouldn’t move the needle in the VIX, which relies more on higher priced options to calculate its index price.
If you’re interested in black swan protection. Now is a great time to buy cheap puts. For example, let’s look at the SPDR S&P 500 ETF (NYSE: SPY), which is trading at all-time highs.
With the ETF trading at $244, let’s say you wanted to buy one month of protection 10% below current levels. Right now the June 30th 220 puts are only trading for $0.14. So a 10-lot (protecting 1,000 shares of SPY) would cost only $140. That’s a tiny amount compared to the risk of a crash scenario.
If you’re at all worried about a correction, I highly recommend allocating at least a small percentage of your funds towards downside protection. Options prices are rarely this cheap. While I don’t expect a major selloff to suddenly materialize out of nowhere, volatility could ramp up pretty quickly if investors suddenly decide political turmoil could spill over into the market. Again, this isn’t likely to happen, but it’s also hard to argue with the low cost of hedging right now.