Cost of Hedging Weekly Update 12-21

by Jay Pestrichelli on December 21st, 2012

At Friday’s open option prices reflected a notable rise in the cost hedging.  The short-term hedging costs rose to 1.21 bps per day and the mid-term price moved to 1.27 bps per day. 
See data for the past 17 months on our Resources Page
If I had written this post just yesterday, it would have been a slightly different story. However, this morning, the markets 1% sell-off at the open reflect the failure of the House’s legislation aimed to provide a solution to the Fiscal Cliff. Personally, I would have expected a bigger jump than this, but we'll get to that in a second when we look at the VIX. The moves today impacted short-term hedging costs more than the mid-term costs. 

We attribute this to the perception that these bumps in the road as we approach January 1st impact March hedges more than June hedges.  Said another way, the outlook for a decline by June doesn't really change all that much regarding when and how the Fiscal Cliff is handled. March, on the other hand, is reflecting more volatility the harder we go over the cliff.
The VIX opened today at 19.85, the highest it’s been since July 24th. As a reference, at that time, the cost of hedging was closer to 1.80 bps per day, or nearly 50% more than it is right now. As we’re said before, the VIX is an even shorter reflection of market sentiment as it aims to portray the volatility over the next 30 days.
I understand the cliff talk is more broken record talk, but it is dominating the market’s right now. Unfortunately, when we see something completely take our attention away from the long-term view, we usually miss what is really important. The market is a vehicle that USUALLY reflects 3 to 6 months out for our economy.  However, right now it seems as if the uncertainty of a recession driven by government policy is blinding and impacting normal behavior.

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