By Saqib Iqbal Ahmed
NEW YORK (Reuters) – Demand for options to protect against a stock market decline is rising, even as a post-election rally pushes U.S. stocks to record highs.
Concerns about the possibility of a contested election eased following President-elect Donald Trump’s victory earlier this month, helping the S&P 500 rise to a record high. The Cboe Volatility Index, a measure of investor anxiety, closed near a post-election low of 14.10 on Tuesday.
But several barometers that measure the adoption of protection against extreme market swings – such as the Nations TailDex index and Cboe Skew – are rebounding. While the rise in these indices does not necessarily mean that investors expect catastrophic events, they do suggest greater caution against several important risks, including the potential for an inflationary pullback amid turmoil in global trade next year.
One of those risks came to light Monday night, when Trump promised big tariffs on Canada, Mexico and China, detailing how he will implement campaign promises that could trigger trade wars.
Although U.S. stocks largely shrugged off the comments, Trump’s broadside evoked memories of the trade-driven market swings that took place during his first term, bolstering the case for portfolio hedging.
Amy Wu Silverman, head of derivatives strategy at RBC Capital Markets, said investors are protecting themselves against so-called fat tail risks, options jargon for higher expected probabilities of extreme market moves.
“While investors generally hold long positions in stocks, the tails are thicker,” he said. “This is due in part to an increase in the geopolitical risk premium and certainly to potential political risk as Trump returns to the presidency and potentially enacts tariffs and other measures.”
The Nations TailDex Index, an options-based index that measures the cost of hedging against a huge move in the SPDR S&P 500 ETF Trust, has risen to 13.64, double its post-election low of 6.68. The rate is higher now than about 70% of the time over the past year.
The Cboe Skew Index, another index that indicates the market’s perception of the likelihood of extreme price movements, closed at a two-month high of 167.28 on Monday.
VIX call options, which offer protection against a market sell-off, also show some of this demand for protection against “tail risks.” The VIX’s three-month call bias, a barometer of the strength of demand for these contracts, is near the highest level in more than five years, according to an analysis by Susquehanna Financial Group.
“The general idea is that there’s an 80-95% chance of fairly low volatility, which is why the VIX is relatively low, but you’re just factoring in a tail event,” said Chris Murphy, co-head of derivatives strategy at Susquehanna.