Fascinating story in today's Wall Street Journal ("Why Markets Have Lost Their Cool," 12/5/19/ B12) that offers at least a partial answer to the question, why have markets been so calm over the past month?
The answer is "swarms of investors betting against volatility itself" through options. Fund and hedge fund managers have built their biggest option positions since 2017, highlighted by Ray Dalio's now-famous $1.5 billion position that runs through March.
The key is that there's a lot of demand for these options, making it profitable to sell them. Since the asset managers don't want to be on that side of the trade, banks have stepped in. They make money if the options expire; i.e., no market swoon over the period of the market and lose otherwise. So banks are now putting more money into stocks to hedge their own downside. So, the author Mr. Sindreu says, while tornado insurance doesn't decrease the number of tornadoes, volatility insurance does decrease volatility.
Unless, of course, the downturn happens anyway. Here's his key line: "The problem with this feedback loop is that when a 'tornado' finally shows up, perhaps in the form of bad news about the economy, volatility shoots up violently as all bets unwind together."
(Good article. Support good journalism.)
And so if you're watching an old Western tonight and hear, "I don't like. It's quiet. It's a little too quiet," think of us!
David
