Risky business

Macro Man doesn't often delve into single-name space, because the due diligence required to make an informed investment is decidedly more micro than macro, and he simply does not find it particularly interesting.  Still, he can appreciate a nice salacious scandal as much as the next chap, particularly in a name that enjoys wide (or at least noisy) ownership.  Yesterday's report that sent Valeant tumbling wasn't exactly a deep dive into the minutiae of the company's business model and financials, but still managed to ask a couple of decidedly uncomfortable questions that point to some sort of fraud.  And oh! the irony!  One of Valeant's largest shareholders (who apparently went on the telly yesterday to trumpet additional purchases) is the same bloke who's always claiming Herbalife is a fraud.  Remember, kids: becoming a distributor so you can buy fat-kid shakes at a discount is fraud, but secretly owning a chain of dodgy pharmacies that buy your products but don't pay is just good clean fun!

Anyhow, Macro Man and a friend were chatting yesterday about option skew and various indices to measure it.  His mate pointed out something called the Credit Suisse Fear Barometer (any reference implied by that acronym is strictly Freudian, we are assured), which purportedly calculates the put strike that you can buy for zero cost in return for selling a 3 month 10% out of the money call.  The greater the distance from spot (i.e., the higher the index), the greater the fear.  It seemed simple enough until your author pulled up a chart, and saw that the index moved in lockstep with the SPX over the last couple of months...but not in the way you'd expect.  Clearly something is amiss with the calculation of the index.

This got Macro Man thinking....why not just look at good old fashioned risk reversals (i.e., the buy/sell of a call/put of identical deltas) and see what they say?  So he punched up the data on his trusty Bloomberg, and while it can be a little sloppy, here's what he got:

That makes a bit more sense....a sharp increase in the demand for puts a couple of months ago, which has generally receded as conditions have settled.   Note that the bid for puts is still above the generally prevailing levels of the past few years, however.  Perhaps it's a reflection of prior positioning, but puts never went quite so psycho bid in Eurostoxx....

China is a really interesting chart.   Using FXI as a proxy, we can see that at the height of the equity rally bubble this summer, riskies were actually bid for calls!   Uh....that was a bad idea, and when it reversed, it reversed hard.  Interestingly, however, the bid for puts has receded tremendously in the last few weeks.  A sign of complacency, or that hot money's gotten out?

There'd appear to be little opportunity for complacency in Brazil, where the Bovespa is the 4th worst performer globally (and Macro Man's ashamed to admit that he had to look up the location of one of the lower three!)  One would normally expect such execrable performance to be met with a massive demand for puts, but according to the Bloomberg data, it hasn't really materialized.   Some of this may reflect the fact that weak hands have gotten out; shares outstanding of the ETF are less half of what they were three years ago.   Then again, the level of out-of-the-money implied vols are quite high on an absolute basis, perhaps dissuading purchasers of naked options.

Finally, what of IBB?  Unsurprisingly, biotech puts remain relatively well bid compared to broader country indices, reflecting both the shoddy performance of the underlying and (perhaps more importantly), the relatively heavy positioning in the industry.  Indeed, shares outstanding of IBB reached an all time high at the end of September.

Summing up, what do we find?

Most of the risk reversals surveyed are at or slightly above longer-term averages, reflecting neither complacency no panic at the present juncture.  The exceptions are biotechs, where puts remain very well bid, and China...where they don't.   Obviously the horse has already bolted in Shanghai equities, but between the low level of the FXI risky and the apparent bottoming of USD/CNH, it doesn't look like a bad time to slap on hedges for China tail risk if you are so inclined.