Traders are behaving cautiously today, to say the least, as they
suffer through the post-Alcoa, poor-home-sales hangover ahead of the
Federal Reserve’s release of the minutes from the FOMC’s March 18
policy meeting. Yet implied volatility, in VIX terms, is up less than 2
percent.
The VIX may be saying that a lot of people think the credit crisis
is over and the recession is baked into current market prices, but
there are plenty of reasons to remain cautious. Current low volatility is giving option buyers an opportunity to hedge their core long positions with puts.
Assuming we’re long anything at this point, what puts would
we use as a hedge, and how many do we need? First, we have to figure
out how our portfolio moves in relation to the market. We know that
four out of five stocks move in the same direction as the market trend,
but by how much? Two numbers can give us a pretty good idea: beta and
R-squared.
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