By Saqib Iqbal Ahmed
NEW YORK (Reuters) – Demand for option protection against a stock market crash is growing even as a post-election rally pushes U.S. stocks to record highs.
Concerns about the possibility of a contested election subsided following President-elect Donald Trump’s victory earlier this month, allowing the S&P 500 to climb to a record high. The Cboe Volatility Index, a measure of investor fear, closed at a post-election low of 14.10 on Tuesday.
But several barometers that measure adoption rates to protect against extreme market swings – such as the Nations TailDex Index and Cboe Skew – are on the rise. While the rise in these indices does not necessarily mean that investors are expecting catastrophic events, they do signal increased caution in the face of some major risks, including the possibility of an inflationary response to the ruptures in global trade next year.
One such risk came to the fore late Monday, when Trump promised high tariffs on Canada, Mexico and China — detailing how he will implement campaign promises that could spark trade wars.
While U.S. stocks largely shrugged off the comments, Trump’s broadside evoked flashbacks to the trade-driven market swings that occurred during his first term, strengthening the case for portfolio hedging.
Amy Wu Silverman, head of derivatives strategy at RBC Capital Markets, said investors are guarding against so-called fat tail risks, options speak for higher expected odds of extreme market moves.
“While investors generally remain long equities, the tails are thicker,” she said. “This is partly due to an increase in the geopolitical risk premium and certainly due to potential policy risks as Trump returns to the presidency and may implement tariffs and other measures.”
The Nations TailDex Index, an options-based index that measures the cost of hedging against an outsized move in the SPDR S&P 500 ETF Trust, rose to 13.64, double its post-election low of 6.68. The index is now higher than about 70% of the time in the past year.
The Cboe Skew Index, another index that reflects the market’s perception of the likelihood of extreme price movements, closed Monday at a two-month high of 167.28.
VIX call options, which provide protection against a market sell-off, are also seeing some of this demand to protect against “tail risk.” According to an analysis by Susquehanna Financial Group, the VIX’s quarterly call skew — a barometer of the strength of demand for these contracts — is hovering around the highest level in more than five years.
“The general idea is that there’s an 80-95% chance of fairly low volatility. That’s why the VIX is relatively low, but there’s just more consideration for a tail event,” said Chris Murphy, co-head of derivatives strategy at Susquehanna.
Maxwell Grinacoff, equity derivatives strategist at UBS, said Monday’s tariff promise by Trump is the kind of risk investors could worry about in the coming months.
“It gives people another reason to start hedging,” he said. “You’ve seen more of a return to downward hedging.”
Investors are also grappling with uncertainty about how deeply the Federal Reserve will be able to cut rates in coming months, as central bankers face a stronger-than-expected economy that could trigger an inflation recovery if they ease monetary policy too far. The Fed will hold its final monetary policy meeting of the year on December 17 and 18.
The war between Russia and Ukraine and the conflict between Israel and Hamas could also contribute to the market’s flare-up.
UBS’s Grinacoff said next year could show parallels to 2018, when stocks hit new highs at the start of the year only to fall as trade and tariff headlines hurt growth expectations and increased volatility across asset classes.
Investors’ demand for protection is “justified in my opinion,” he said.
(Reporting by Saqib Iqbal Ahmed; Editing by Ira Iosebashvili and Matthew Lewis)
