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Regional Index Options Could Cushion Equity Drawdowns
Equity markets have become more volatile in recent years. Our analysis shows that median volatility rose to 19.4 (2019-24) from 14.1 (2014-19), largely in response to the COVID-19 pandemic and geopolitical and macroeconomic events.1 This greater uncertainty has also led to U.S. index- and equity-options volumes doubling in 2023 compared to 2019.
What is the market's perception of volatility going forward? Post the volatility spike on Japan’s Black Monday, implied volatility (based on at-the-money options) has risen again in several regional markets as of early September. Furthermore, the term structure of options inverted across all regions, an indication that investors perceive higher short-term risks than long-term risks. Despite perceptions of heightened risk, put-option premiums are still trending below their median, based on the last five years of data, potentially suggesting a lower cost to insure against heightened volatility.
Options strategies have offered protection in the past
Over the last 18 years, options strategies linked to the MSCI Emerging Markets (EM) and MSCI EAFE Indexes have provided downside protection and exhibited lower drawdowns during turbulent markets. Our analysis indicates that conditions similar to those we observed in EM and EAFE, such as higher volatility and inverted term structure, currently exist in other regions.
As global markets continue to face risks that include market concentration, crowding and a possible hard landing, understanding regional perceptions of near-term risks and the historical performance of options strategies during volatile periods can offer valuable insights for managing market uncertainty.
Options’ implied volatility rose in September after August spike
Regional near-term risk perceptions vs. Japan’s Black Monday
1 Data periods are from Sept. 2, 2014, to Aug. 30, 2019, and Sept. 3, 2019, to Sept. 6, 2024. Equity volatility represented by the Cboe® VIX® Index.
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