High VIX Means Credit Volatility Might Be the Place to Hedge

The disconnect between the surge in price swings in equities and a much calmer corporate bond market offers an opportunity for investors to hedge risk via credit, according to Tallbacken Capital Advisors LLC.

The ratio of the Cboe High Yield Corporate Bond ETF Volatility Index to the Cboe Volatility Index is near historically low levels, data compiled by Bloomberg going back to 2015 show. That feeds in to the pricing of options which means investors can pick up relatively cheaper portfolio buffers in the credit market, against the possibility of a pull back in risk sentiment, said Michael Purves, strategist and chief executive officer at Tallbacken.

High VIX Means Credit Volatility Might Be the Place to Hedge

The situation represents “a good opportunity to find some protection for long credit positions and/or a pan-asset de-risking,” Purves wrote in a recent note.

Implied volatility measures in U.S. fixed income remain low relative to equities amid loose monetary policy and $120 billion of monthly bond purchases by the Federal Reserve. In stocks, expectations for price swings jumped during the Reddit-led retail frenzy and remain elevated versus longer-term averages. The VIX closed Monday at 30.24, compared with its lifetime average around 19.5.

“Equity volatility still implies that credit risk remains underpriced,” Societe Generale SA strategists including Andrew Lapthorne wrote in a note Monday. “But ultimately the risk is that fundamentals will reassert themselves and spreads then go higher.”

Read More: Volatility Disconnect May Spur Hedging Opportunities in FX

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