By Saqib Iqbal Ahmed
In New York, a surge in the demand for options protection is making waves, even as the stock market climbs to unprecedented heights following the U.S. election. The fears surrounding a contested election subsided after President-elect Donald Trump’s victory earlier this month, driving the S&P 500 to new records. Meanwhile, the Cboe Volatility Index, which serves as a measure of investor nerves, settled near a post-election low of 14.10 on Tuesday.
Despite this uptick in the market, there’s still a noticeable increase in measures tracking the demand for safeguarding against major market upheavals. Indicators like the Nations TailDex Index and Cboe Skew are on the rise. While these increases don’t necessarily signal investor expectation of catastrophic events, they do reflect a heightened level of caution amid various significant risks. These include the potential for inflationary rebounds or disruptions in global trade in the coming year.
One such risk came into sharper focus late Monday when Trump announced his plan for substantial tariffs on Canada, Mexico, and China. This move outlines how he intends to fulfill his campaign commitments, which could ignite trade wars. The U.S. stock market largely brushed off these remarks, but they were a stark reminder of the trade-induced market swings seen during his first term, making a stronger case for portfolio hedging.
Amy Wu Silverman, who leads derivatives strategy at RBC Capital Markets, noted that investors are bracing for what are termed “fat tail risks.” In options terminology, this refers to the increased likelihood of significant market movements. “Investors generally remain bullish on equities, yet these risks have expanded,” she explained. “This is partly due to the rising geopolitical risk premium and the potential policy threats as Trump returns to the presidency with the possibility of imposing tariffs and other actions.”
The Nations TailDex Index, based on options, evaluates the cost of hedging against drastic movements in the SPDR S&P 500 ETF Trust and has surged to 13.64, doubling its post-election low of 6.68. This index sits higher than it has about 70% of the time over the past year. Additionally, the Cboe Skew index, which reflects the market’s view on the probability of extreme price changes, closed Monday at a two-month high of 167.28.
Protection against market downturns is also visible in VIX call options, which have captured some of this demand for safeguarding against “tail risks.” According to Susquehanna Financial Group, the VIX three-month call skew—a measure of the demand strength for these contracts—is near its highest in over five years. “The essence here is while there’s an 80-95% chance of relatively low volatility, there’s more focus on the likelihood of a tail event,” commented Chris Murphy, who co-leads derivative strategy at Susquehanna.
Maxwell Grinacoff, an equity derivatives strategist at UBS, remarked that Trump’s recent tariff announcement is precisely the type of risk that could lead investors to start hedging once more in the coming months. “It’s a trigger for renewed hedging,” he said. “We’re seeing a shift back towards protective strategies.”
Investors are also navigating uncertainties regarding how much the Federal Reserve can reduce interest rates in the foreseeable future. Central bankers face the challenge of an unexpectedly robust economy that could risk an inflationary surge if they ease monetary policy too aggressively. The Fed’s final monetary policy meeting of the year is scheduled for December 17-18.
Further tension stems from the ongoing Russia-Ukraine conflict and the violence between Israel and Hamas, both of which could incite market volatility. Grinacoff from UBS mentioned that the coming year might mirror trends seen in 2018, where stocks reached new heights early on, only to falter as trade and tariff news dented growth expectations, driving up volatility across asset classes. “Given the landscape, seeking protection is certainly justified, in my view,” he concluded.
