Cost of Hedging Weekly Update 12-4

by Jay Pestrichelli on December 3rd, 2012

The week’s data is starting to show some signs of concern slipping into options pricing. We saw the price of short-term hedging rise to 1.1 bps per day and the mid-term price move up to 1.34 bps per day. 
See data for the past 15 months on our Resources Page
These aren’t levels to get alarmed about, but they are a move up from the low costs we wrote about last week. This could be a function of two things. First, the jobs data comes out Friday and that always adds volatility to option prices.
Second seems to be that the Republicans are starting to dig in their heels on tax hikes or any increased spending cuts. It is starting to look more and more as if an agreement in advance of the fiscal cliff will be harder to form. At the very least the market thought that the majority of Americans would not see their taxes jump, but now it seems like there is very little common ground after the weekend and the market is getting fearful.
I struggle to figure out why the market ever thought there would be any agreement at all considering the size of the issue at hand and little amount of time there was left to deal with it. However, it did seem almost certain that the tax hike on the middle class would be resolved, but now not so much.
What the market may be figuring out is the impact of the spending cuts. It seems both parties want them to happen and this will undoubtedly cause pain to the unemployment numbers, but that won’t be visible until early Feb next year when the January jobs data is released.
Last week did see some contrarians speaking out that going over the fiscal cliff would be short term pain and a long term solution to some of these issues. But we’ve yet to hear from them Monday.
In our previous update we talked about 3 data points that lead us to believe the market had less fear. This week all of them are beginning to reverse. Volatility is higher, the spread between the mid and short term cost hedging is closing, and the cost of hedging in general is on the rise.
Overall, the cost of hedging is still relatively low and could honestly look anyone in the eye and tell them that they did not miss the boat on building protection. If the bears do grab the market with both hands and shove it down, we could see a 5% pullback to the lows of mid-November in just 2 sessions. Those would be bad sessions, but we really are just 2 sessions away from a lower low / lower high downward trend scenario. 

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