These Are The Cheapest Crash Hedges Right Now
The comments below are an edited and abridged synopsis of an article by Tyler Durden
With the smart money exiting the stock market in droves, yield curves collapsing, extreme speculative positioning in bonds and a dramatically diverging economic reality from market narratives, the possibility of a crash is rising.
Everyone’s looking at the Bloomberg SMART Money Flow Index and Aggregate Treasury Futures Net Speculative Positioning.
So what’s the cheapest way to hedge against a crash scenario? Ranked by the average, the chart (included here) shows the hedges that are most underpricing historical drawdowns.
Precious metals regain the most-favoured nation status as the world’s emerging markets collapse and economic reality washes ashore on the banks of the river of excess debt.
Historically there have been 3 distinct cross-asset correlation regimes since 1995. Interestingly, there is a broadly upward trend since October 2003, well before the Lehman bankruptcy in September 2008. This is related to the liquidity-driven crush in asset risk-premia that helped drive investment leverage higher. Long-term correlation established a new regime since 3Q13, similar to the 2003 to 2008 correlation environment.
And these are the 2-month-forward historical stress peaks, compared to current levels, if that systemic crash should occur.
The chart (included here) illustrates why it is useful to consider the relative pricing of options across asset classes to hedge against tail events: Option markets often underestimate the severity of market shocks, and to different degrees. In 2008, currency and equity volumes were the most optimistic ahead of the Lehman crisis and the most surprised after (rose to the highest levels).