Published - May 10th, 2023 @ 11:28 AM (CET)
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Investors are showing growing concerns about a potential stock market crash, as demand for insurance against such an event has surged to multi-month highs. Even though the US stock market has calmed since a choppy start to the year, investors are taking positions that would pay out if stocks slump, indicating a sense of unease about the future. One of the key indicators of investor anxiety is the Cboe Volatility Index, which is hovering close to its 18-month lows. However, the three-month skew on the S&P 500 - which measures the relative demand of puts versus calls - has hit its highest level since December 2021. Puts convey the right to sell shares at a fixed price in the future, while calls offer the right to buy shares.

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_{According to Anand Omprakash, head of derivatives and quantitative strategy at Elevation Securities, the high skew suggests that investors are pricing in a sharp stock slide rather than the steady grind lower seen last year. Omprakash said, "Behind the scenes, option traders are very wary."}

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The demand for crash protection surged in March as the collapse of Silicon Valley Bank and Signature Bank roiled the banking sector. Though stock market gyrations have subsided recently from levels hit during the regional banks' crisis, investors see plenty of catalysts for volatility ahead. These include the prospect of an unprecedented US default that could come within weeks if Congress does not raise the country's $31.4 trillion debt limit.

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Rising allocations to stocks among investors who cut their exposure to the bone last year also give market participants a reason to seek protection. According to Deutsche Bank data, institutional investors' stock exposure has increased after slumping in 2022 to a decade low, excluding the COVID-19 market crash of March 2020.
The recent drop in volatility, with the VIX falling to around 18 from a high of nearly 40 last year, is another reason skew measures have increased. As volatility falls and markets grind higher, the chance of a sudden, sharp drop increases. This has pushed market participants to shift some tail risk hedges - options positions that guard against the risk of significant financial losses from an unforeseen event - toward downside protection, according to Susquehanna strategist Christopher Jacobson.
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Despite the market's heightened anxiety, there may be a silver lining for stocks. The S&P 500 tends to fare better over the next one-, two-, three-, and six-month periods when the three-month skew measure is in the 90th percentile or higher, as it is now than when the bar is in the middle or bottom of its range, according to a Nomura analysis of data going back to 1997.
One explanation has to do with the mechanics of options hedging. When investors purchase hedges against a stock drop, market makers - typically large banks or financial institutions - often manage their risk by selling stock futures. If markets rise and the options hedges expire, dealers may be forced to buy back the stock futures they shorted, providing an additional boost to markets.
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In conclusion, while the stock market remains unpredictable, investors can take measures to protect their portfolios against potential risks. The recent surge in demand for insurance against a stock market crash suggests that investors are growing increasingly wary, which could lead to higher levels of market volatility in the months ahead. However, history has shown that such periods of heightened anxiety may bode well for stocks, as they tend to fuel a potential market melt-up.

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The information on mexem.com is for general informational purposes only. It should not be regarded as investment advice. Investing in stocks involves risk. A stock's past performance is not a reliable indicator of its future performance. Always consult a financial advisor or trusted sources before making any investment decisions.

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