Short-vol equity strategies can deliver returns even as economies hurtle toward recession -- but the journey is famously bumpy. In 11 Fed easing cycles since 1972, the realized volatility of the S&P 500 rose “reliably’’ in the months preceding the first rate cut, according to Bank of America Corp.
With some Wall Street recession signals still flashing, hedging for an end-of-cycle uptick in volatility has a clear appeal. But trading with conviction is a challenge given the relative stability of the macro climate.
“As long as fundamental data -- the volatility of inflation etc. -- is very low we would avoid any strategic trades and only tactically examine periodic opportunities,” said Yannis Couletsis, director at Credence Capital Management Ltd.
If short-vol trades famed for their dependable income are offering thinner returns while long bets look risky, it may be a case of being nimble.
QVR’s Eifert is pursuing relative-value trades that “isolate specific market dislocations, as well as cheap, low-carry-cost long volatility positions.” He points to strategies across the volatility surface of the S&P 500 as an example. Long-term interest-rate swaptions are a potentially cheap way to bet on rising volatility, he said.
For Hennessy at IPS, the relatively low premium available from shorting VIX futures makes options contracts more attractive given the subdued volatility of volatility itself.
Meanwhile, some hedge funds in the becalmed $5.1 trillion-a-day foreign exchange market are snapping up riskier instruments from managed futures to gold.
Hedging Trades
There’s an upside to all this for real-money investors: Hedges are looking cheap. At a unit of Allianz, one of Europe’s biggest insurers, low price swings are offering the chance to load up on U.S. interest-rate derivatives.
“We are taking advantage of very low volatility to manage very actively the complexity of our portfolios,’’ said Franck Dixmier, global head of fixed income at Allianz Global Investors. “We were able to play some downward momentum on rates in buying calls and then playing a correction buying puts.”
All told, step back and the killer question continues to haunt traders of all stripes: At what point will market confidence in the ability of central banks to prolong the cycle give way?