Have You Heard The One About The Dirty Shirt And The Flat Skew?

Last week, Goldman suggested it might be time for investors to hedge. Their rationale is as follows:

We believe the VIX spike in early February was a significant event for investors, made even more significant last week as we revisited the YTD lows in the S&P 500. S&P 500 realized volatility was 6.8 in 2017 and has nearly tripled to 20.3 thus far in 2018. We expect the increase in realized volatility to have direct effects on the calculation of risk in a variety of equity portfolios (when volatility rises, position sizes need to decrease to maintain the same dollar-volatility risk). The spike in VIX and realized volatility was large enough for investors outside the equity market to take notice and could lead to a reduction in risk-taking appetite on the margin in the coming months. It was yet another symptom of the market fragility created by lower liquidity. We believe that a shift towards risk reduction and expectation of higher volatility is likely to change the trading dynamics in 2018 and increase the value of time spent on hedging.

Sounds plausible, right? Goldman even went so far as to provide you with a handy bullet point list of tautological hedging instructions like “hedge when you think the risk is greatest” – that’s in case you don’t know what hedges is or what they does (to borrow a deliberate grammar error in the service of humor from Thornton’s regulation headline).

Goldman would go on to say that “more recently, open interest data reveals that a large number of S&P 500 hedges have expired over the past three weeks, leaving the average investor less hedged.”

Bloomberg’s Dani Burger picked up on that theme for a recent piece, noting that the Cboe SKEW Index “has been falling for the last two weeks, and is now two standard deviations below its average level [while] another options-based gauge, the Credit Suisse Fear Barometer, hit its lowest level since 2016 on Monday.”