While the markets are breaking new records, some traders are taking a step back to hedge against the likelihood of a fallout that could end the rally. Exchange traded fund investors can also protect themselves against potential turns with alternative strategies as well.
U.S. markets are rallying, but options traders have looked at the new high with caution, betting on the eventual misfortune of a S&P 500 pullback in the coming months, the Wall Street Journal reports.
“People still are traumatized by this time last year,” Julian Emanuel, chief equity and derivatives strategist at BTIG, told the WSJ. “The glass is still half empty…It’s shocking because you wouldn’t think that would be the case at all-time highs.”
Emanuel underscored the high demand for stock protection for contracts expiring in a few months to a whole year from now, which has driven up the cost of bearish put options on the Cboe Skew Index, which measures expectations of extreme and unusual moves in the stock market, or so-called black swan events.
“There’s a signal out there that while we’re up at the highs, there’s still some kind of concern that we give back some of these gains,” Ling Zhou, an equity derivatives strategist at Cowen, told the WSJ.
Among the various factors on the wall of worry, the U.S. presidential election remains a primary suspect, with rising investment concern over policy stances that a Democratic nominee would hold.
“The biggest risk for 2020 is the U.S. presidential election,” JPMorgan analysts said in a note, recommending portfolio hedges that expire in March after Super Tuesday.
ETF traders who are looking to protect their portfolios from potential pullbacks in the current market rally may consider some exposure to bearish or inverse ETFs to hedge against further falls.
For example, the ProShares Short S&P500 (NYSEArca: SH) takes a simple inverse or -100% daily performance of the S&P 500 index. Alternatively, for the more aggressive trader, leveraged options include the ProShares UltraShort S&P500 ETF (NYSEArca: SDS), which tries to reflect the -2x or -200% daily performance of the S&P 500, the Direxion Daily S&P 500 Bear 3x Shares (NYSEArca: SPXS), which takes the -3x or -300% daily performance of the S&P 500, and ProShares UltraPro Short S&P 500 ETF (NYSEArca: SPXU), which also takes the -300% daily performance of the S&P 500.
Other investors have turned to volatility exposure to hedge risks, such as the iPath Series B S&P 500 VIX Short Term Futures ETN (VXX), ProShares VIX Short-Term Futures ETF (VIXY) and VelocityShares Daily Long VIX Short-Term ETN (VIIX). Volatility typically rises when stocks pullback, so owning volatility is seen as a type of market insurance. The VIX is a widely observed indicator for investor sentiment in the stock market and measures the expected or implied volatility of large-cap stock options traded on the S&P 500 index. ETFs that track VIX futures allow investors to profit during rising volatility or hedge against short-term turns.
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