UBS issues market squall warning

Prepare for a storm when insurance is cheap, says UBS.

The Swiss bank's equity derivative strategy team notes that since 2008 there have been three to four occasions a year when the S&P 500 fell more than 5 per cent, or when the CBOE Vix index, the volatility gauge, jumped more than 50 per cent, within a month.

To date in 2014, the only "meaningful correction" was between January and February, when the S&P lost 6 per cent and the Vix rose from 12.1 to 21.4.

"To take advantage of the current low implied volatility, low volatility of volatility ... and low correlation, investors may want to buy insurance against a potential drawdown in the next few months."

The bank believes the chances of a squall are all the greater because hedge fund net leverage is at the highest since 2011, "yet their risk tolerance is low given their underperformance".

Careful. A shift in Fed policy gets closer as the S&P flirts with 2,000 ahead of next week's US jobs report. The often awkward autumn months approach.

At the open on Thursday the September 2014 Vix future was priced below 14. Such is the market's confidence that the Vix future curve is pretty flat, with the April 2015 contract priced at just 17.2.

Insurance is indeed cheap.

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