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BofAML Says Even the Options Market 'Too Tired' to Price Risks

Joanna Ossinger

(Bloomberg) -- Many investors have been fatigued by the ups and downs across markets -- and derivatives may be no different.

Bearish put options on the Hang Seng China Enterprises Index are cheapest among global equities despite risks from the trade war and the unrest in Hong Kong, Bank of America Merrill Lynch strategists led by Stefano Pascale wrote in a note Aug. 28. And currency put options are near their cheapest levels in 10 or more years despite risks, which are “yet another example of complacency,” they said.

“Are you tired of this market?” the strategists asked. “Option markets reflect your pain.”

In terms of hedging against an S&P 500 portfolio, the strategists see the iShares MSCI Japan exchange-traded fund as a good candidate. Puts on the ETF would have been better at protecting against downside than those on the U.S. benchmark itself in all of the 10 largest drawdowns since 2006, according to the report, while payers on U.S. high-yield credit were most attractive on average but had a wider range of results.

Volatility has been elevated across asset classes in recent weeks as investors contend with trade salvos from the U.S. and China, a global economy that shows some signs of weakening and the shift to an easing cycle by the Federal Reserve. Added to that are geopolitical tensions in places like Hong Kong, the U.K., Argentina and Italy. The Cboe Volatility Index, or VIX, closed Thursday at 17.88, a decline on the day but well above its floor from early summer. The Merrill Option Volatility Estimate, which measures Treasury option swings, reached its highest level in three and a half years on Aug. 23.

Foreign-exchange put options are the cheapest in a cross-asset ranking, the strategists said, with the exception of the British pound as it contends with Brexit issues. Currency puts are close to the best-ranked they have been on BofAML’s screen since 2008, they said, “despite the obvious risks of the trade war becoming a currency war.”

“Like many investors, many options simply seem too tired to price risks that are too hard to predict,” the strategists said.

(Updates VIX level in fifth paragraph.)

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