Volatility is Back - Now What?

Feb 09, 2018

Vol is Back-Now What?

As we look at the stock markets precipitous drop the last few days, we believe this to be a swift and violent unwind of the short volatility trade. We do not see a dramatic risk of contagion or liquidity crisis based on our multi-asset models. That said, we do think that the credit-related sectors could see some follow-through and underperform equities in the coming days/weeks. These models show that while inter-asset correlations have moved up somewhat on higher volatility, they remain at the lower-end of historical levels. This could mean that multi-asset investors perceive the equity volatility to be more purely a volatility squeeze and not a fundamentally-driven issue. With this in mind, we recommend a few strategies should the correction expand slightly to other asset classes.

1. We believe it is likely high yield underperforms equities in the coming weeks. (Long SPY vs. Short HYG)

2. For Asian related credit concerns we think buying FXY call spreads are a solid hedge. The Yen often is considered an Asian safety asset and has a tendency to offset Asian credit and equity crises effectively. In addition, with global central banks looking to raise rates, we think the Yen has macro support as well.

3. Option volatility is likely to normalize once the short volatility unwind is complete. We believe the best ways to capitalize on this is via 1 month duration bear put spreads in VXX.