For years, institutional investors paid billions for portfolio hedges (mostly put options) not because they improved returns, but because they felt like talismans against market catastrophe. Now, after years of disappointing investment performance, these same investors are abandoning hedges entirely. The shift is quiet and behavioral, visible in charts but not in announcements. It represents a fundamental change in how markets function.
• Put-buying patterns have vanished. The ratio of put options to call options on the CBOE shows an unprecedented collapse in protective hedging. Spikes that used to occur every few months whenever market fears arose have simply stopped appearing, despite plenty of reasons to be scared. The behavior that sustained an entire market structure has evaporated.
• The dollar amount of actual market protection is plummeting. Delta-adjusted open interest on S&P 500 puts has crashed from approximately $230 billion in late 2015 to roughly $70 billion today, the lowest level in five years, and the trajectory suggests it's heading toward nothing. This isn't a minor adjustment. It's the unraveling of an entire hedging infrastructure.
• Volatility-selling strategies benefited for years because of this behavior. When investors got scared and bought protective puts, volatility traders sold them at a profit. When the bogeyman didn't arrive and the puts expired worthless, the premiums stayed with the sellers. This machine depended entirely on naturally long-only investors being willing to lose money repeatedly for the psychic benefit of feeling protected.
• The Fed is being positioned as the real hedge. The implicit assumption now is that central banks will always step in to prevent serious market declines. Why pay for put options when the Fed provides protection for free. But this reasoning has a fatal flaw that Hunt identifies without spelling it out.
• The real question isn't what market crashes the Fed can prevent. It's what the Fed won't prevent, and what happens when investors finally realize they've surrendered protection against the threats that matter most. The monsters we should be hedging against operate in plain sight, already inside the system, with absolute entitlement and zero intention of asking permission.
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Comments
I dont know how many times i looked at the date of this note to make sure it wasnt just written. (The China and US relations stuff in here made me double take, along with many other things.)
Because this post has had some time to age, have you changed your opinion on any of this?
Regardless, Im scared of the vampire… I started reading your note: I know it was you, Fredo.
But do you have anything new or other related topics, books, videos, etc. to learn more about options, convexity, risk?
Id be also interested to know if anyone on the forum has any experience in this past year or two and how that played out?
Continue the discussion at the Epsilon Theory Forum...