Investors are piling up insurance against further market sell-off

Investors are buying record amounts of insurance contracts to protect themselves from a sell-off that has already wiped trillions of dollars off the value of US stocks.

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

In the past week alone, institutional investors have spent $9.6 billion. The splurge underscores the extent to which major funds want to protect themselves from a nine-month sell-off, and has been fueled by central bankers around the world aggressively raising interest rates to tame high inflation.

“Investors have realized that [US] The Federal Reserve is very policy-limited with inflation where it is and they can no longer rely on it to manage the risk of asset price volatility, so they need to take more direct action on their own,” said Dave Jilek, chief investment strategist at Gateway Investment advisor. .

Jason Goepfert, who leads research at Sundial, noted that when adjusted for growth in the US stock market over the past two decades, the volume of purchases of put options on stocks was about equal to the level reached during the financial crisis. By contrast, demand for call options, which can pay out if stock prices rise, has declined.

Line chart of premiums spent to initiate new put options, 4 weeks behind ($bn), showing major money managers hedging as the market slides

While this year’s sell-off has wiped out more than 22 percent of the benchmark S&P 500 stock index — turning it into a bear market — the decline has been relatively controlled and lasted for months, not weeks. That frustrated many investors who hedge with put option contracts or bet on a rise in the Cboe’s Vix volatility index, but found the protection didn’t work as the intended shock absorber.

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

For the past month, money managers have instead turned to buying put contracts on individual stocks in the hopes that they can better protect portfolios as they hedge against big moves in companies like FedEx or Ford, which have fallen dramatically after issuing profit warnings. .

“You’ve seen this extreme disruption. It’s very rare to see this dynamic where single stock premiums are offered so much relative to the index,” said Brian Bost, co-head of equity derivatives in America at Barclays. “That’s a major structural shift that doesn’t happen every day.”

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

Line chart of short-lived volatility skew showing demand has shifted to hedging declines in individual stocks

As stocks fell again Friday, with more than 2,600 companies hitting new 52-week lows this week, Cantor Fitzgerald said his clients took profits on hedges and opened new trades with lower strike prices as they took out new insurance policies.

Wall Street strategists have lowered their year-end forecasts as they factor in tighter Fed policies and an economic slowdown that they warn will soon eat away at corporate profits. Goldman Sachs cut its S&P 500 forecast Friday, expecting a further fall in the benchmark as it cut its bet on a year-end rally.

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

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