Cost of Hedging Weekly Update 1-3-13

Posted on January 3rd, 2013

It’s been a pretty crazy week and half since we last updated the cost of hedging data.  As it stands now, the short-term costs sit at 1.06 bps per day and mid-term cost dips to 1.18 bps per day. Both of these are trending lower over the last two days as the market has had a nice 4% rally in just the last 48 hours.
 
See data for the past 18 months on our Resources Page
 
However, go back to 12-28 and there was a very different story brewing. Hedging costs were about 40-60% higher than where they are now and peaked at levels not seen for months. Actually, the short-term costs were the highest since June. Obviously the lack of a fiscal cliff deal was finally creeping into the pricing of options. The normally fast to react option traders really missed this one. The day they decide to take the deal crisis seriously was one day too soon to act. The market slapped them around as it tends to do and reversed with a vengeance just the next day.
 
It’s rare to see the option traders get it so wrong, but boy did they ever mess this one up. The whole time since the election they kept the VIX relatively low and played this off as if it was nothing but an overhyped media event. Option prices stayed low and the cost of hedging even hit a relative low point back in mid-December.  At the time it was curious to see it and as the topic of the cliff dominated the headlines, fear couldn’t “out-emotion” greed.
 
That is all up until the 28th. The market made a 1 day move of 1.4% and it seemed as if the options trader just flipped out. It was as if they lost all their courage and ran up put costs to by 20-30%. We even saw the short-term costs jump above the mid-term, which is a bearish indicator when sustained. It was a massive speculative bet that backfired just one day later when the costs then plummeted.
 
The old saying reminds us that as the first week goes, so does the month and as the first month goes, so does the year. If that is true, it should be a very interesting positive year based on just the first day. It’s time to shift attention to Friday’s December jobs data and the earnings season results and outlooks.
 



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