Saqib Iqbal Ahmad

NEW YORK, (Reuters) – Wall Street has seen a rebound in risk appetite after a difficult start to 2012. However, strategists caution that the pause in volatility could be temporary and warn investors against further stock market gyrations.

Cboe Volatility Index (an options-based index of anticipated 30-day volatility in U.S. stocks) fell to 22.81 on Tuesday — just two weeks following closing at a 1-year high.

This has occurred in conjunction with a rally of the. The rally has been fueled partly by Fed assurances that the U.S. economic system is strong enough for more aggressive monetary policy tightening to curb inflation. After confirming the correction in October, the index remains at 5%.

Options strategists warn that recent gains may be temporary and advise clients to purchase volatility hedges. These have been cheaper recently as portfolio protection demand has declined.

Catalysts for future volatility eruptions range from worries that the Fed’s hawkish tilt will drag the economy into recession – an idea that is roiling bond markets – to further geopolitical uncertainty stemming from Russia’s invasion of Ukraine, which Moscow calls a “special operation.”

Matthew Tym of Cantor Fitzgerald’s equity derivatives trading said, “With no demand to buy protection, there will be a tendency for the to soften…but as we saw mid-February that could change in a matter of a minute.” If I see the VIX drop another point, then I believe that it is bottoming.”

BoFA Global Research strategists agreed with this sentiment. They believe that worries over high inflation, slowing economic growth, and a Fed that is too hawkish are likely to increase stock market weakness.

In a Tuesday note, they said that the “risk-on price action” and lower cost protection were not a rallying call but rather an opportunity to load on hedges.

An S&P 500 put option that would guard against a 10% decline in the index through mid-June costs about 30% less now than a week ago, Refinitiv data showed.

According to Trade Alert data, the 1-month moving average for open puts contracts against open calls of the SPX index is the lowest it has been since July 2020. This measure measures defensive positioning.

Some investors have reduced their exposure to stocks over the past week due to high volatility. This could be one reason that hedge demand has dropped.

BofA Global Research’s March survey showed that fund managers have their cash at its highest level since April 2020. A measure of equity position was also tracked by Deutsche Bank Recently, (DE) dropped to its lowest level since September 2020.

WallachBeth Capital senior strategist Ilya Feygin stated that there is less risk to hedge.

To be sure, analysts have also noted that sharp drops in the VIX have often preceded short-term upside in stocks: the S&P 500 has historically returned 2.5% and been up 77% of the time following a five-day drop in the VIX, wrote Christopher Murphy, co-head of derivatives strategy at Susquehanna International Group.

However, others point out that VIX closed at or below 18% for three of the last twelve months and are not optimistic it will settle soon.

The VIX curve remains flat right through November. That suggests traders believe markets will remain choppy most of the rest of the year.

Randy Frederick (Vice President of Trading and Derivatives at the Schwab Center for Financial Research) said, “It suggests volatility remaining around where is it now for a while.”