These Are The Cheapest Crash Hedges Right Now

With the “smart” money exiting the stock market in droves, yield curves collapsing, extreme speculative positioning in bonds, and a dramatically diverging economic reality from market market narratives, the possibility of a crash – Fed triggered or not – is rising.

What do ‘they’ know?

And with everyone on the same side of another boat…

So the question is – what’s the cheapest way to hedge against a crash scenario?

Bank of America’s Jason Galazidis has some answers…

Ranked by the average, the screen below shows that the hedges which are most underpricing historical drawdowns are:

Gold calls, US HY Credit hedges and EUR 10y receivers

And so – once again – the precious metal regains ‘most-favored-nation’ status as the world’s emerging markets collapse and economic reality washes ashore on the banks of the river-of-excess-debt…

Since the middle of January, gold implied vol has been notably, systemically lower than stocks…

And European equity vol has started to normalize back to its premium to US equity vol…

Cross asset risk is once more in benign territory relative to history as vols and credit spreads are all in their 1st 11y quartile…

Additionally, 12M cross-asset-class correlation has continued its climb since the Feb-18 equity-led sell-off, now reaching 5y highs…

Historically there have been 3 distinct cross asset correlation regimes since 1995. Interestingly, we see a broadly upward trend since Oct-03, well before the Lehman bankruptcy in Sep-08. This is related to the liquidity driven crush in asset risk-premia that helped drive investment leverage higher.  Long-term correlation established a new regime since 3Q13, similar to the ’03 to ‘08 correlation environment.

And these are the two-month-forward historical stress peaks, compared to current levels, if that systemic crash should occur…

The chart illustrates why it is useful to consider the relative pricing of options across asset classes to hedge against tail events: option markets often underestimate the severity of market shocks, and to different degrees. In 2008, currency and equity vols were the most optimistic ahead of the Lehman crisis and the most surprised after (rose to the highest levels).