Cost of Hedging Weekly Update 1-28-14

by Jay Pestrichelli on January 28th, 2014

What a difference a week brings. The sharp decline in the stock market have sent the cost of hedging to levels we haven’t seen since the October fears of a debt default.   As of the Jan 27th the short-term daily cost was 0.93 basis points per day and the mid-term cost out to September 2014 was 1.09 basis points per day.  
See data for the past 29months on our Resources Page

Volatility has returned to the options market after the S&P 500 declined 63 points (3.4%) in just 3 days. The VIX had an out sized jump comparably as it moved 4.6 points (36%) over the same time. However, in the big picture of things, this is still not considered a high level by most standards. For example this latest peak failed to reach any of the highs of 2013 and barely surpassed the average for all of 2012 which was 17.8.
So while many are asking the question “Is this the big one?” the options market isn’t showing any signs that it is. Yes, options prices are higher than they were last week, but we’re still not too concerned with the cost of hedging. Therefore we’re still adding positions using close to the market hedge levels and going out our normal 6-12 months.
 
For those of us who sell volatility for income, this pop is a welcome one I’m sure. Short puts as entries and short calls to generate income off long positions will feel a little better this week. However, the cost of hedging on a relative basis is still low, so if you’re looking to protect after this move, it’s not too late. Buying the 1600 puts on the SPX will give you protection below a 10% drop at an annual cost of 3.5%. 


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