Cost of Hedging Weekly Update 9-26

by Jay Pestrichelli on September 26th, 2012

Up until about noon yesterday, the story of the cost of hedging was getting boring. It felt almost like we were a broken record talking about low volatility and higher markets keeping hedging relatively cheap. But as soon as there was some disruption in Spain, the market began to sell off and volatility jumped 15% from Monday’s close to mid-day Wednesday. As we know, as volatility jumps, so does the price of options and the cost of hedging follows along.
The jump in the daily cost of hedging has slightly outpaced the rise in volatility, but we need to remember we were at all-time lows just 4 days ago.  Mid-term costs went from 1.2 daily basis points on Friday to 1.42 this afternoon.  Short-term has jumped more from 0.82 daily basis points Monday to 1.08 today.
As a reminder we use daily basis points as a way of comparing the relative cost of a protective put via the SPX as a hedging vehicle. This figure represents the daily effect that hedging will cost for the highlighted options. We also benchmark at the 10% protection level, and of course that should change on an individual-to-individual basis. You can see the updated data on our Resources Page  

As a new option period kicked off on Monday, you may have been able to lock in some of the lower hedging prices for the protection that had expired. However, if you didn’t fear not; as you haven’t missed the boat just yet. The costs are still lower today, after than they were even as recently as a month ago, so if you have unprotected positions, it’s not too late.  If this market is indeed starting its correction, you may find yourself wishing you had.
On the flip side, those of you who have not sold calls yet (calls are used as a way of offsetting the cost of the put protection) should remember that higher volatility means higher premiums you can generate. And even though the market may be slightly lower, the VIX over 20 will naturally be reflected as higher prices of calls. Volatility is a double edged sword and while its low, protection is cheap, and when its high, the calls can generate more income. Getting caught on the wrong side of it can get expensive, which is why we track it in the first place.

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