Cost of betting on a stock-market crash is cheapest since 2008, says BofA

“Since our data began in 2008, it has never cost less to protect against an S&P drawdown in the next 12 months,” according to a team led by Benjamin Bowler, BofA’s top global equity-derivatives strategist.

Relatively low equity volatility coupled with rising interest rates — the Federal Reserve is widely expected to deliver another 25-basis-point interest-rate hike on Wednesday — and low correlation among different corners of the stock market has created a “historic entry point” for hedges, the team said.

According to the team, the cost of buying S&P 500 puts and put spreads expiring in 12 months is even lower today than it was in 2017, when the Cboe Volatility Index VIX, +4.20%, otherwise known as the “Vix” or Wall Street’s “fear gauge,” touched its all-time low below 9. By comparison, the gauge finished Tuesday at 13.86.

A put is an option contract that could pay off if the underlying stock or index were to fall by a certain amount over a given period. The level at which an option goes “in the money” is called the “strike price.” Traders can typically exercise or sell “in the money” options for a profit, so long the cost of purchasing the option has also been offset. Equity options give traders the right, but not the obligation, to buy or sell.

In options trading, a “spread” is a type of strategy that involves selling one option contract to offset the cost of buying another.

The team recommended buying puts that would pay off if the S&P 500 SPX, +0.99% were to fall by 5% over the coming year. But for investors who are looking to take a bigger swing, they also recommended a put spread that would involve selling an even further out-of-the money S&P 500 put to offset the cost of buying the 5% out-of-the money put mentioned above.

Upfront premiums paid on such a trade is in the low single-digits, meaning the cost of protection is a small fraction of the index’s price in the spot market.

If the S&P 500 were to falter, the put spread recommended by the team could offer a max payout of more than 8-to-1.

In a sense, the cost of bearish options on the S&P 500 has gotten so low, it almost doesn’t make sense. There appear to be far more potential stock-market landmines nowadays than there were back in 2017.

U.S. stocks finished higher on Tuesday with the S&P 500 rising 0.3% to 4,567.46. Meanwhile, the Nasdaq Composite COMP, +1.90% rose by 0.6% to 14,114.56 while the Dow Jones Industrial Average DJIA, +0.50% rose by 26.83 points, or 0.1%, to 35,438.07, clinching its longest winning streak in more than six years.