If It's the Big One for Stocks, Hedgers Look Unprepared

(Bloomberg) -- Maybe the warnings got boring.

Trade tensions between the U.S. and China are escalating, the Nasdaq 100 Index is set for its ninth straight 1 percent swing, and safe havens are in fashion around the world. Yet hedging activity is decidedly muted, all things considered.

By one measure, equity investors have been this disinterested in guarding against tail risks -- or an extraordinary spike in volatility -- only three other times in the past decade. The Cboe SKEW Index, which tracks the cost of out-of-the-money S&P 500 Index options, has been falling for the last two weeks, and is now two standard deviations below its average level. Another options-based gauge, the Credit Suisse Fear Barometer, hit its lowest level since 2016 on Monday.

That's not to say traders aren't hedging at all. The Cboe Volatility Index remains above 20 -- a level it never reached in 2017 -- and is pushing higher as markets digest China's latest retaliatory measures against proposed U.S. tariffs. But if rising trade tensions cause a massive volatility pick-up, investor insurance is scant. Goldman Sachs Group Inc. urged boosting protection after many S&P 500 hedges expired over the past three weeks.

“At face value, the current level of the Skew Index may represent a lack of concern around an imminent left-side ‘tail risk,'” Tim Emmott, executive director at Olivetree Financial Ltd. in London, wrote in a Tuesday note to clients. “Sounds like a set up for quite the reverse for the medium term.”

Emmott points out that some of the de-leveraging may be due to the recent declines in U.S. stocks. Investors bought up protection in early March, and cashed out as the downside move materialized, he said. The last time the SKEW index tracked this low was the day the S&P 500 posted its worst selloff in more than six years, on Feb. 5.

To be sure, lows in the SKEW index have preceded VIX drops, not the other way around. The volatility benchmark has lost about 35 percent since Feb. 5 and fell in the month following SKEW lows in the past two years, data compiled by Bloomberg show.

Caution is also missing in another corner of the market where traders bet against stocks and profit when they decline. Short sales as a percentage of total shares available for trading stood at 3.9 percent as of mid-March, according to the latest exchange data compiled by Bloomberg. That's below the three-year average of 4 percent and down from the peak of 4.4 percent reached after the market's last 10 percent correction in 2016.

--With assistance from Lu Wang

To contact the reporter on this story: Dani Burger in London at dburger7@bloomberg.net.

To contact the editors responsible for this story: Samuel Potter at spotter33@bloomberg.net, Cecile Vannucci, Sid Verma

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