Strategic Volatility and Hedging Amid Tariff Uncertainty: Navigating the Current Market Conditions
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Global Markets Vol Weekly
1. SPX spot down / vol down continues to encourage using put spreads to hedge, although wide- ranging VIX means that there are opportunities each week to consider adding either lookback feature (when vols are lower) or VKO feature when vols are more elevated.
2. What if recent challenging headlines and data points were to reverse, amid broad tone of bearishness in the market? After spot and vol declines of recent sessions, it’s now very cheap to hedge the upside tail via defensive low-premium calls in both US and Europe.
3. UBS Research constructive on EURUSD medium-term, but flagging near-term downside risk, mainly linked to tariffs. Trade via RKI calls, or short-dated put options, with downside-strike implieds still relatively low.
4. US curve continues to steepen but with 2y forwards already at UBS Research year-end target level, investors can switch 2s30s structures into 10s30s Bull Steepeners or play a Fed staying on hold amid elevated inflation via 2s5s Floors and 2s10s Bear Flatteners.
Vol Market Observations:
- Equity markets uniformly down on the week as Tariff concerns increased ahead of “Liberation Day” led by KOSPI2 and NKY.
- The sell-off saw Equity fixed strike vols up across the board, led by Asian indices given the magnitude of their spot sell-offs.
- Skew was also mostly higher on the week, especially on the upside with SPX 3m 100-105%F skew at its 94th % vs 3yrs.
- FX vols were more mixed than equity vols, EUR and JPY pairs saw the largest increases in ATM vol but some crosses like EURCHF and EURNOK saw vols slightly lower while USDCNH interestingly also vols down despite the potential for China-focused tariffs on Wed.
- Gold spot resumed its rally, up 3.7% WoW, but implied vols remain subdued with 3m ATM vol actually down slightly despite the rally.
- Cross-asset vols quite mixed on the week, equity vols uniformly higher, Rates vols mostly higher, FX vols more mixed and Commod vols mostly lower on the week with the exception of Brent.
SPX spot down / vol down continues to encourage using put spreads to hedge, although wide-ranging VIX means that there are opportunities each week to consider adding either lookback feature (when vols are lower) or VKO feature when vols are more elevated:
- Elevated intraday vol yesterday into month-end, with SPX trading down 1.65% initially, before rallying steadily back by 2.5% to close higher on the day.
- This took VIX as high as 24.8v shortly after the open, before closing down at 22v on the close.
- These swings make it challenging to recommend a single static hedging approach, and we would continue to tend more towards:
1. Vanilla puts and put spreads when vols are at the lower end of the range, and liquidity potentially a concern on a sell-off (which could make monetization of more exotic alternatives challenging). Vols remain relatively unstretched for many indices on p10 (SPX 3m 95% put costs 1.84% indic).
2. Lookback puts when those lower vols come alongside a more heavily depressed spot level – giving the potential to benefit from a quick restrike higher on any meaningful spot bounce through e.g. tariff catalysts this week. The cost of a SPX 3m 95% daily lookback put is indic offered at 2.54% (please call for firm refresh given rapidly-changing markets), which is 70bps / 38% more expensive than the vanilla put and equivalent to the cost of a 3m 97.4% vanilla, meaning that the lookback put only requires a quick ~2.5% rally (like yesterday) in order to justify the increased premium outlay vs the vanilla.
3. VKOs when VIX approaches 25 and beyond – for example, even now (with vols not looking particularly stretched), investors can cheapen a 3m 95% vanilla SPX put by 42% (from 1.84% to 1.07% indic) by applying a VKO at 32.5v; a level only very rarely exceeded during a 3m window over the last 15yrs (see chart bottom right that shows 3m realised staying resolutely sub 32.5v in all but the Covid spike, and very briefly in 2011). At today’s 2m SPX realised vol of just 17.5v (and even at the 1m realised of ~20.5v), the VKO MtM would gradually converge to the vanilla, and in doing so help mitigate time decay concerns, especially if spot stays somewhat under pressure while tariffs are announced and digested.
