(Bloomberg) -- It’s a volatile time in the markets these days, and fortunately, strategists aren’t lacking for ideas on how to trade the action.
The S&P 500 has moved more than 1% for five straight sessions, the longest streak since November 2020. The Cboe Volatility Index, or VIX, hit its highest level since January on Wednesday and that’s even before the monthly non-farm payrolls number comes out in the U.S. on Friday.
The volatility is rearing its head as Covid-19 continues to loom over economic and policy decisions, supply-chain issues flare up and many central banks look to pull back on pandemic-era stimulus amid rising inflation. Geopolitical risks including simmering U.S.-China tensions add to the mix.
Here’s what some strategists are saying about how to handle the current environment:
Bet on ARKK Downside
Hedging via the S&P 500 is inadvisable, according to Michael Purves, chief executive officer at Tallbacken Capital Advisors LLC. It’s expensive and the equity risk premium is still in good shape for anyone who isn’t a “massive bear” on Treasuries and corporate earnings, Purves wrote in a note Thursday.
“The best risk/return is set up in the corner of the market where valuations comes down more to stories than to numbers,” he said, recommending a put-option spread on Cathie Wood’s Ark Innovation ETF as a market hedge, or simply shorting it.
Back to Basics
“Sometimes when the VIX volatility index explodes northward and issues swirl in investors heads, it’s best to return to the basics and ask a simple question: Will real company earnings rise in the coming year?” said Jim Paulsen chief investment strategist at Leuthold Group, in a note Thursday. “Because if the answer is yes, despite whatever extraneous problems are at play, the stock market usually finds its way through the storm and rises.”
VIX at 29...
The increase in volatility has Katie Stockton, founder of Fairlead Strategies LLC, watching “whether the VIX will finish the week decisively above our risk threshold of 29.” That’s about where it topped out during spikes in May and September, though it closed above 31 on Wednesday before falling to 27.95 on Thursday.
Read more: VIX Action During Omicron Slump Seen as Positive Sign for Stocks
...or Above 30
The VIX flipping from a close below 30 to above it has tended to generate positive returns on the S&P 500 over the past 15 years, according to data compiled by Bloomberg.
Watch S&P for 3%
“Much as we still like U.S. equities, it’s time to plan for more severe volatility,” said Nicholas Colas, co-founder of DataTrek Research LLC, in a note Thursday. The issue to watch, he said, is if the S&P 500 drops more than 3% in one session.
A 3.4% decline on Feb. 24, 2020, combined with the VIX closing near 25 -- “statistically too low” -- was a sell signal coming after a long period with no drops of that magnitude, Colas said. The current setup is similar, he added. Colas will be a buyer on a drop of more than 3% “if (and only if) the VIX closes well above 44.”
VIX Too Active
“Since Omicron has reared its head, markets have been chaotic and volatile,” said Tom Lee, co-founder of Fundstrat Global Advisors LLC, in a note Thursday. “However, we do think this is an interruption in a continuing bull market.”
“By some measures of VIX activity, the market panic has nearly matched the panic in March 2020,” Lee added. “Does that make much sense given that lockdowns are off the table and the population is immeasurably safer and better prepared than in that chaotic time? We think not.”
A VIX calendar strategy has been shown to deliver alpha systematically, according to JPMorgan Chase & Co. derivatives strategist Peng Cheng, in a note Wednesday, and may be good for medium- to high-volatility regimes like the current one.
When the VIX is above 20, an investor can sell a front-month 20 delta put -- with delta a gauge of an option’s price sensitivity to changes in the price of an underlying asset -- and buy the second-month 20 delta put, at a one-to-one ratio, Cheng wrote in a note Wednesday. “The trade is carried till the expiry of the front-month contract, and unwound if VIX is 20 or below, and if VIX is above 20, rolled into the same put calendar structure,” Cheng said.
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