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:
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
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