The data reveals that hedge fund money has not been chasing the January late December – January rally in US stocks. It is on the sidelines.
According to Macro Risk Advisors, these big-money managers are acting much more like it is the aftermath of the Y 2008 financial crisis than the relatively low-volatility environment that has dominated for most of the past five years.
The combination of hedge fund’s implied equity exposure to the S&P 500 Index (SPY) and associated trends in the options on that benchmark gauge reveals the extent of their risk aversion.
Some equity derivatives strategist highlight this dynamic, as reminiscent of the financial-crisis backdrop for US stocks.
The portion of hedge funds’ returns attributable to the S&P 500, the trailing 3 -month beta is at its lowest mark since Y 2013. Meanwhile, there is relatively low demand for Puts despite the December hammering in equities and this subsequent rebound.
Accordingly there are 2 explanations.
Hedge funds may have added more to their Short than Long books in which case Calls, rather than Puts, would be the appropriate hedge. or they do not need to hedge because they have not and are not loading up on Long positions in US stocks.
While speculative investors have not been buying up tail hedges, the exposure of equity hedge funds to the S&P 500 has fallen with skew. The current level of equity exposure for hedge funds is more consistent with the 2008-2013 market regime than the Y’s 2014-2018 Bull Market.
On the other hand, periods of higher hedge fund exposure to equities tend to occur in lie with elevated option skew, offering a trading opportunity in options for investors willing to bet that these managers will warm to US stocks and spur this rally.
“In this environment, owning delta-hedged risk reversals (buying puts, selling calls, and buying shares — a direct bet on skew) could be a unique way of betting on hedge fund exposure to equities rising,’’ wrote 1 derivatives manager to his clients Wednesday. “Naturally, that phenomenon should occur if the market continues to rally back from the carnage that happened in Q-4 of Y 2018.’’