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Contagion!

By:

Chief Strategist at Interactive Brokers

Last month I co-hosted an hour on Yahoo Finance, and it’s customary for guest contributors to suggest a word of the day. Mine was “contagion”.

At the time, I had no idea what path the Covid-19 virus would take, but I worried more about the contagion of ideas.  Fear could become contagious, leading people to act viscerally rather than intellectually.  That fear finally took root today, with major US indices down 3-4% at the time I write this.

Markets had been quite sanguine after a brief dip at the end of January.  The market’s willingness to take on risk, chasing performance, is contributing to the ferocity of today’s selloff.  Many market observers refer to the CBOE Volatility Index (VIX) as the market’s “fear gauge”.  I don’t like to use that nomenclature, but a quick glance as the VIX Index futures curve shows the overnight change in sentiment:

Source: Bloomberg

For those of you who are unfamiliar with this analysis, the above charts the level of the various levels of sequential VIX futures.  The different lines show snapshots of these futures curves at various points in time, with the green line being today’s reading.  We can see the dramatic jump in the green line versus the orange line below it, which is Friday’s close.  This type of move, with spot and short-term futures leaping dramatically, shows a remarkable increase in the demand for options protection today.  In general, backwardation in a futures market (when short term futures prices exceed those of longer term futures) reflects relative scarcity.  It’s not unreasonable to expect a scarcity of protection on a day like today.

Many of you have heard me state multiple times that the time to hedge is before an event, not during one. While it may not be pleasant to be reminded of this on a day like today, please keep that in mind the next time that markets go up.

Disclosure: Interactive Brokers

The analysis in this material is provided for information only and is not and should not be construed as an offer to sell or the solicitation of an offer to buy any security. To the extent that this material discusses general market activity, industry or sector trends or other broad-based economic or political conditions, it should not be construed as research or investment advice. To the extent that it includes references to specific securities, commodities, currencies, or other instruments, those references do not constitute a recommendation by IBKR to buy, sell or hold such investments. This material does not and is not intended to take into account the particular financial conditions, investment objectives or requirements of individual customers. Before acting on this material, you should consider whether it is suitable for your particular circumstances and, as necessary, seek professional advice.

Disclosure: Futures Trading

Futures are not suitable for all investors. The amount you may lose may be greater than your initial investment. Before trading futures, please read the CFTC Risk Disclosure. A copy and additional information are available at ibkr.com.

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