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After the $13 trillion stock crash, traders are ready to fight back


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Judging by the ominous statements from Wall Street celebrities, every trader under the sun should prepare for new turmoil in the world’s largest stock market.

However, hedging against doom and gloom is out of fashion, thanks to historic equity trends that erased $13 trillion in market value this year and made both Retail and institutional investors are excluded.

In the options market, the relative cost of contracts to pay if the S&P 500 Index falls another 10% has fallen to its lowest level since 2017. The appetite for bullish bets is on the rise. . And the popular Cboe Volatility Index is well below multi-year highs even as the stock benchmark falls to bear market lows.

All of that may sound strange because the Federal Reserve is still trying to deliver positive rate hikes like a snowball of recession risk. But traders are getting tired of reading the old bearish mantras. Equity spreads have fallen to historic lows, while soaring inflation and currency hawks are hardly new threats.

“When there’s so much skepticism out there, maybe things aren’t really that bad,” said Gary Bradshaw, a portfolio manager at Hodges Capital Management in Dallas, Texas. “We were very close to paying the price with all the headwinds. The story is getting more and more repetitive and traders are getting fed up.”

Feelings of burnout, low bars for good news and higher bars for bad news help explain why the S&P 500’s slow burn seems to produce fewer fireworks during the day. Meanwhile, the impulse to chase potential gains in the stock market at a historically strong time of year has come in late. In the rare sessions when the S&P 500 actually rallied in October, it posted an average gain of 2.4%, a gain 1.8 times larger than the average drop this month. That’s the widest rate since October 2019, data compiled by Bloomberg shows.

That doesn’t mean traders are optimistic. The VIX is still hovering near 30, reflecting expectations that stock prices will hover around normal during these uncertain times. However, given historical inflation and the fearsome interest rate outlook, it could be much higher. Thinking that clear positioning is reducing the need for a bearish hedge. For example, systemic managers’ equity ratios are hovering near lows seen only twice in the past decade – during the European debt crisis and the March 2020 pandemic – according to Deutsche Bank AG.

With cash on the sidelines, some investors are warming to the idea that most of the bad news is over and favorable seasonal patterns may not be in play yet. Since 1990, the three-month period starting October 10 has given the S&P 500 an average gain of 7%, data compiled by Bespoke Investment Group shows. On a rolling basis, it was the strongest three-month trading period of the whole year.

“Aware that while we are not there, we are probably closer to finding the optimal bottom,” said Steve Sosnick, chief strategist at Interactive Brokers LLC. “We have a healthy data set of unknowns, but after 10 months we might be closer to figuring everything out.”

Likewise, a full-blown recession threatens to land next year, and the Fed appears powerless to deliver a dovish offset as in previous downturns. That’s why Chris Zaccarelli, chief investment officer at the Alliance of Independent Advisors, advises caution.

“A lot of people who are trading in this market are still using the buy-sell-embed game,” he said in a phone interview. “It has worked before, but this is the first time in 40 years that inflation has been a serious problem and things have changed.”

Currently, however, it is difficult to see panic attacks in the world of options hedging. Take the Cboe Skew Index, which tracks the cost of no-money S&P 500 options, reflecting the need for tail risk protection. The index has fallen in six of the past eight weeks to hit the bottom of readings since early 2010.

Meanwhile, few people want to bet on a higher VIX by buying long positions, with the Cboe VVIX Index, a measure of metered volatility, oscillating at muted levels. And overall, demand for bullish S&P 500 contracts is growing against downside risks.

Charlie McElligott at Nomura Securities International Inc. wrote in a note to clients: “Customer needs are completely focused on the right tail/collapse”. “They’re scared about missing out on the big rally when they don’t own any/enough facilities.”

–With support from Justina Lee.

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