Yesterday, courtesy of Bank of America, we showed an extensive catalog of how a trader could, in case the market “were to crash tomorrow”, hedge said crash risk crash using the cheapest derivative instruments.
But the real question of course is whether a crash is indeed coming?
As Bank of America notes, a traditional telltale sign of crashes is a surge in correlation among various otherwise uncorrelated assets.
Which is notable because as we showed earlier, the correlation among two key asset classes, namely stocks and oil, have soared to record highs…
… while the respective vol correlations is likewise surging, as one would expect, soaring.
This, to many traders, is the first clear sign that something is seriously wrong and a broad selloff may either be imminent or necessary to short circuit a market in which all correlations are converging.
And yet, as BofA shows with the chart below, option markets always underestimate the severity of market shocks, and to different degrees. In 2008, currency and equity vols were the most optimistic ahead of the Lehman crisis and the most surprised after. This time around equity vol is modestly elevated, but it is rate vol – the vol which many say is at the core of the entire financial system – that is surprisingly depressed.
So for those who are inching closer to the “crash is imminent” camp, we suggest taking a look at the chart below showing the stress levels, or rather lack thereof, 2 months prior to every major crash in the past decade, and extrapolating how far said “stress” may soar to in the coming 8 weeks if, as Citi, JPMorgan and Deutsche Bank today suggest, central banks are on the verge of losing control…
via Zero Hedge http://ift.tt/1SIRq5x Tyler Durden