- Stock market volatility is locked near record lows.
- Bank of America Merrill Lynch says there’s never been a better time to protect against an imminent market shock.
At this point, anyone following the stock market knows that price swings are non-existent.
So what should investors do? Bank of America Merrill Lynch thinks it’s time to prepare for an inevitable shock — or as it describes it, an “overdue fragility event.”
And investors are in luck, because hedges against a sharp stock market selloff are the cheapest they’ve ever been, says BAML. The firm specifically recommends shorting one S&P 500 put contract on the benchmark falling to 2,275 by June for every two put contracts bet long on the index to hit 2,500 by December. The S&P 500 closed at 2,564.98 on Monday.
“The entry point for S&P ‘fragility hedges’ in the form of put ratio calendars has never been more attractive,” BAML analyst Nikolay Angeloff wrote in a client note. “This is a trade worth considering if you disagree with the market’s implied belief that risk does not exist.”
The attractiveness of the entry point comes from the steepness of the S&P 500’s term structure, where near-dated contracts are expensive relative to those further in the future. Further, put skew — or the degree to which future protection is more expensive than at-the-money options — is high because of the market’s tendency to buy more stock exposure on short-term dips.
You can see that dynamic at play in the chart below.
So why not throw some protection on? It’s cheap, and if the market sees a downturn, you’ll be glad you did.