Several volatility hedge funds are either cutting their exposure significantly or actually shutting their doors. It has not been a good environment for volatility hedge funds.
These are not run of the mill situations. Some are friends, others professional acquaintances, most are very good. To me this illustrates just how severe and how quickly the structure of the markets have changed.
The liquidation of these portfolios is significant enough to have an impact on option prices, and have consequently contributed to the decline in overall volatility. The other factor, of course, is the immense liquidity and other machinations as provided by the Fed.
As stocks grind higher, most see this as a sign of economic healing. The Federal Reserve represented by Chairman Greenspan and Governor Bernarnke have publicly and frequently encouraged this view.
I continue, however, to see things differently. I view the low option prices as increased leverage (again, not to the levels that they were in the mid 1980’s). I view the recovery hinged on too much new debt. I view the massive government intervention, executed primarily by the U.S. and Japan, as unsustainable. For a succinct and well thought analysis of this situation, I highly recommend that you read Stephen Roach’s (Morgan Stanley economist) latest piece entitled “Fed Hubris”.
I also am acting on my beliefs. The volatility (through options) that others are selling, I am currently buying. I may be falling into the same trap as the others fell victim to, but if Mr. Roach is right, at some point in the coming months, the market will have a volatility event that will tear through current option pricing.
No positions in stocks mentioned.
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