Stocks ended their worst week since June on Friday, yet the options market showed a comparatively restrained response. Analysts tracking volatility and demand for protection against further losses pointed to signs that investors were being selective about hedging, even as the S&P 500 fell nearly 2% for the day.
The Cboe Volatility Index, or VIX, briefly reached its highest intraday reading since April before pulling back to finish at 19.4. Brent Kochuba of SpotGamma described its 2.2-point increase as relatively muted given the size of the stock market decline. His analysis of 126 selloffs dating to 2018 suggested that a drop of that magnitude would have been accompanied by a VIX increase closer to 2.6 points.
Trading in Nasdaq 100 options also revealed an uneven appetite for protection. Although implied volatility rose across most contracts, data shared by Nasdaq’s Kevin Davitt showed exceptions among put options that were 20% to 50% out-of-the-money. On a volatility basis, those contracts had been more expensive following the Oct. 16 selloff than they were after Friday’s decline.
Separate figures from Nations Indexes likewise showed that Nasdaq puts had cost more two weeks earlier. Together, the observations suggested traders were choosing their Nasdaq hedges carefully while also refraining from a rush into S&P 500 options. Nomura managing director Charlie McElligott wrote that investors were not aggressively pursuing out-of-the-money S&P 500 puts.
In a Friday client note, McElligott said index options skew had shown limited reaction to several days of falling share prices. Where it had responded, he attributed part of the movement to declining implied volatility in call options. That pattern offered another indication of investor calm despite the weakness in stocks.
One possible explanation is that asset managers have been selling shares directly rather than retaining their positions and buying options to guard against additional losses. A Morgan Stanley prime brokerage chart circulating over the weekend showed total global gross equity exposure among long-short active managers had fallen 8% from its latest peak, the largest drawdown in at least a decade.
Zed Francis, chief investment officer at Chicago-based Convexitas, described a substantial reduction in leverage as managers bought back short positions and sold long holdings. He argued that moving closer to cash reduced the need for hedges, and said this was the main reason implied volatility had remained subdued during a month of increased stress.
