Saturday, December 29, 2012

Washington forcing investors into the options market

Back in July we discussed the mispricing of equity risk that was visible in the low levels of the VIX (implied volatility) index (see post). Making money by shorting equity options and riding the decay became fashionable after Draghi put in a backstop for the Eurozone periphery and the Fed started taking volatility out of the market (see discussion). But those shorting options got punished today. Demand for short-term equity options spiked, driven by the dysfunction in Washington. VIX (and VIX futures) jumped some 17% in a single day.


WSJ: - Late-day fiscal cliff news out of Washington Friday provoked the biggest one-day percentage gain in the market’s so-called fear since gauge November 2011.

With just three days remaining to reach a budget agreement to advert the year-end tax increases and spending cuts known as the fiscal cliff and no solution in sight, the Chicago Board Options Exchange’s Volatility Index Thursday jumped to the highest level since June.
Investors don't trust Washington to get a resolution any time soon and are willing to pay a high premium to protect themselves. The risk-on trade is on.
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