Seasoned investors, staring at a world clouded by war, inflation and economic uncertainty, are buying catastrophe insurance at a record clip.
Institutional traders paid $8.1 billion to initiate purchases of equity puts last week, the highest total premium in at least 22 years, Options Clearing Corp. data compiled by Sundial Capital Research show. Adjusted for market capitalization, demand for hedges matches levels from the 2008 financial crisis.
The spree is the latest evidence of sky-high anxiety on Wall Street in a market where strategists at firms from Morgan Stanley to Goldman Sachs Group Inc. are warning that the 2022 bear market has yet to see its bottom. Cash holdings rose in mutual funds and hedge funds cut equity holdings to multi-year lows. While all the bearishness set the stage for a short squeeze on Wednesday, it nevertheless speaks of extreme fear among pros.
“They’re buying protection against a crash at a pace unlike anything the market has ever seen,” said Jason Goepfert, chief research officer at Sundial. “The sudden and massive hedging activity of some of the market’s largest traders is unsettling.”
By contrast, demand for bullish options is dwindling. At less than $1 billion, the total premium on calls last week fell to the lowest level since the immediate aftermath of the 2020 pandemic meltdown, Sundial data show.
Driving the surge in puts is demand for single-stock options, according to Brent Kochuba, founder of SpotGamma. With the Cboe Volatility Index and puts linked to indexes like the S&P 500 failing to offer buffers this year, investors are increasingly gravitating toward contracts linked to individual shares.
Rising appetites for protection are visible in the Cboe equity put-call ratio’s 5-day average, which has spiked lately to levels almost never seen since March 2020.
“There is an increase in put buying for ETFs and indicies too. It’s just much more pronounced in equities,” said Brent Kochuba, founder of SpotGamma. “That is because it may be easier to short stocks that are weakened by the macro environment and you get more volatility there too. It’s arguable that index put options are a good buy here based on where realized volatility has been.”
The burst in put activity is viewed in some corners as a source of potential volatility. Market makers who sold these contracts would need to buy or sell underlying stocks to maintain a neutral market exposure. Right now, they’re mired in a “short gamma” stance that requires them to sell stocks when they fall and buy them when they rise, according to Charlie McElligott, a cross-asset strategist at Nomura Securities International. The setup contributed to the S&P 500’s 1.8% jump Wednesday, he said.
One force underlining the sudden demand may be institutional investors looking to protect their stock holdings. Hedge funds, for instance, have spent the past two weeks buying shares of individual companies, data from Goldman Sachs Group Inc.’s prime brokerage show. Those new positions would require fresh hedges.
Another source of puts buyers may have come from bears simply taking advantage of the renewed selloff in technology shares amid a surge in Treasury yields.
“With the addition of some single-name long exposures, clients might then need fresh hedges in those names, so puts were bought,” McElligott said. “More traders wanted to take shots to downside in those tech growth names as rates began to sell off hard with hawkish global central bank escalations.”
Bulls got a respite Wednesday after a losing streak where the S&P 500 fell in nine of the previous 12 sessions. Despite the gain, the index is down about 8% after an unsuccessful test at its 200-day average in mid-August ignited a selloff and the Fed toughened its hawkish stance.
The latest decline marks the end to the market’s fourth failed attempt to mount a recovery this year. Along the way, skeptics grew. UBS Group AG’s strategists including Keith Parker just lowered their year-end forecast for the S&P 500 to 4,000 from 4,150, citing a potential hit to corporate earnings from a slowing economy and higher taxes. On Thursday, the index was flat as of 10:21 a.m. New York time after falling as much as 0.9% to 3,945.
The UBS team sees a wide range of outcomes for the market, given the uncertain path of Fed monetary tightening and its impact on the economy. In the best scenario where inflation eases and real bond yields fall, the S&P 500 could rally to 4,400. By contrast, the index could fall toward 3,100 if aggressive rate hikes lead to a deeper recession, the firm’s model shows.
“Risks are still tilted to the downside,” Parker wrote in a note.
The massive hedging in 2008 proved prescient, though the foray into puts seemed less well-timed in other occasions. To Goepfert, the current frenzy likely reflects group think that may work as a contrarian signal.
“They have sometimes shown an uncanny ability to buy or sell ahead of significant events in a very short time frame. But the data is too limited to suggest that something is necessarily coming down the pike in the next week or two,” he said. “More compelling evidence suggests the record put buying is a sign of panic, which has a good track record of preceding rising stock prices over the medium- to long-term.”
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