Is a Hedged Market a Bull Market?

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Is a Hedged Market a Bull Market?

Every talking head on the planet is talking about how ëlowí the VIX is.  The truth is, the VIX is not low at all (read Jared Woodardís excellent piece for more on this).  Even with all the evidence pointing toward the VIX being fairly priced, the major naysayers are out saying the market is complacent.  That the VIX is going to have to go up, because there is too much risk.  My response is that I think they are wrong, and the at least in the near term, all other things being equal, we are going to continue to rally.  This is because we currently have a well hedged market.  How do I know, read on:

For starters, as Andrew wrote about yesterday the price of SPX OTM puts is super expensive right now.  April and May are both sky high. This implies that funds, hedge funds, and money managers are buying SPX puts to protect existing long positions.
A possibly more convincing argument for this is the cost of VIX options.  While the VIX itself may be well below the long term mean (and even the April Future), the cost of VIX options is NOT below the long term mean.



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Notice how the last time the VIX was around 15 the IV of the options was around 80%, relatively normal.  Shortly thereafter, the market exploded.  This time however, take a look at the cost of VIX options.  They are currently over 100%.  That is a level that is normally only reserved for the VIX when it is exploding higher and trading closer to 30%.  For the VIX options to be this pricy, again shows that the longs are hedging.
To make matters more clear, take a look at the skew of VIX options.



Livevol Æ www.livevol.com

Much like VIX itself, the Skew of VIX is SKY HIGH.  The IV of the 25ís 30s and so on are at levels that we almost never see unless the market is crashing.  This also points toward longs buying protection.

Why is this so important?  One of the great things about an insured portfolio is that it provides a major security blanket to the major houses.  It also points toward a belief that the market is going to rally.  If the major players thought the market was going to fall, rather than buy puts or VIX calls, the houses would simply sell.  A fully hedged market will be less volatile, as stocks are protected.


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