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had protected investors in hedging their portfolios.
But the clamour to buy options—on the VIX and equity
indices—has pushed up the price of option contracts both
in the US and Europe. Euro Stoxx June at-the-money puts
options around 4% at the beginning of March. For a year
the price reached almost 12%, double the figure of last year.
Options are useful to hedge short-term gap risk where prices
might move dramatically overnight, however the high cost of
protection is making this a somewhat prohibitive task right
now.
“It is a question of what kind of risk management you do,”
says Wolfgang Mader, co-head of risklab, part of Allianz
Global Investors (AGI). “Some clients need to use option
hedges because they need hard risk management. But we all
know this is expensive. Even if volatility is not high you still
need to roll-over positions, which is a costly exercise.”
Given the high costs, investors have been looking at selling
long-dated calls to fund their put options purchases. This
has been a particularly popular trade in the UK. But it comes
with its own downside.
“You are looking more at a market going through a bout of indigestion. It is
still possible to take equity risk.”
- JOHN BILTON, GLOBAL HEAD OF MULTI-ASSET STRATEGY, JP MORGAN ASSET MANAGEMENT
“The main problem is that you are giving up upside return
potential by selling the call option,” says Mader. “Say you
have return expectations of between 4% and 6%, you will
be giving up 2% in expected return by implementing such a
collar strategy.”
Currency diversification
So what are the alternatives? In February, a research note
by Morgan Stanley posted a list of hedging assets which had
performed well in February’s sell-off. Currency diversifica-
tion as a hedge against equity risk comes out near the top of
the pile; the bank posited the Japanese yen and Swiss franc
as both cheap and well performing in a rerun of the February
sell-off. Currencies are something that many buy-siders are
more generally looking at right now.
“We prefer to use currencies,” says Wenzel. “The yen and
Swiss franc are liquid and shown to be negatively correlat-
ed to crises. We did some yen and Swiss franc purchases in
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