Don’t Fight The Fed, Don’t Fight The Tape – Still Appropriate?

Required margin levels are far more appropriate now, but remember that options are themselves leveraged investments. Outright call buyers have an advantage over margined stock buyers in that they can only lose their initial premium payment, but options also enable their investors to lose money over and over again. Look at the recent example of Softbank. After a stellar run investing in call options, they recently announced that they will be unwinding that strategy after significant losses. The current wave of call buyers is keeping volatility measures, such as VIX, elevated. Normally, during times of investor enthusiasm, we see VIX plunge. Complacent investors see little need to hedge their downside, depressing options prices, and implied volatilities. 

The current rally has a much more manic quality, with the low levels of the put/call ratio showing that while there is still little interest in hedging downside, there is no shortage of traders seeking to profit from further upside. For the short term at least, the VIX index usefulness as a fear gauge is seriously impaired. (For the record, VIX is not now, nor has it ever truly been a fear gauge, but it has tended to act like one nonetheless). Let’s be real — there much for investors to love. Vaccines are on the horizon, and markets are discounting the likelihood that pent-up demand will bring a sharp boost to the economy and corporate profits. 

The Federal Reserve has given little indication that they will remove their accommodation before inflationary pressures become evident. That raises the specter of an overheated economy in the latter half of next year. But why worry about that now, I suppose? Markets are fixated on the positives, especially during an otherwise gloomy year. It is tough and even foolish to fight either the Fed or the tape. But experienced traders know that nothing obligates you to join the party either. It is also important to use your judgment to decide whether a bit more fear may be appropriate amidst all the current greed.

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