Equities are at an all-time high and the demand for protection of downside risk has collapsed.
The Credit Suisse Fear Barometer (CSFB) is a measure of the protection that can be purchased through 3-month put options by selling 10% out-of-the-money (OTM) 3-month call options. For example, if put options and call options were equally priced for equivalent levels of money-ness, then the proceeds from selling a 10% OTM call could be used to purchase a 10% OTM put. As the demand for hedging downside risk increases, the cost of the puts will increase relative to the calls. When this happens, the proceeds from selling a 10% OTM call may only be able to purchase further OTM put options (e.g. 20% OTM).
What we have seen with the CSFB index for most of this year has been a relatively extreme demand for downside protection. As a case-in-point, the CSFB hit an all-time high of 35.24on March 26, 2013. What this meant is that – at that date – selling a 10% OTM would only be able to finance a put that was 35.24% below the current SPX level! In fact, during 2013, this index has averaged 31.05 when its long-term historical average has been 17.47.
But we have witnessed a notable break during the past two weeks. Read more