How are investors responding to current risk, and is it being accurately reflected in the CBOE Volatility Index (VIX)?
Amy Wu Silverman: Even prior to Iran being top of the news headlines, we already saw issues with software. But because other sectors that were reflecting bullish sentiment, we had relatively subdued index-level volatility.
There are going to be real impacts, even from the short time where we've had issues in the Strait of Hormuz. Then there's a longer-term arch of what this does to rates action, and to longer-term growth and inflation.
Ben Fisher: Clients I speak to say this extreme volatility has made it difficult to make money, just because of the rapidity of the moves and being forced to trade headlines.
What happens if the AI angst, the private credit angst, and then the Iran angst all converge? Then then you probably get that big drawdown.
Silverman: Folks who were long hedges have monetized that. It's very much the 2022 playbook after the Russian invasion of Ukraine.
However, in 2022 the market drew down about 20%, but a systematic put buying strategy actually drew down 21%. So there is a fear that these hedges underperform.
"What happens if the AI angst, the private credit angst, and then the Iran angst all converge? Then then you probably get that big drawdown.”
Ben Fisher, U.S. Equity Sales Specialist
What is the current mood of investors on software and private credit?
Fisher: Anthropic and OpenAI are accelerating growth. The sentiment has gotten better in software because these AI models will need software if they’re to succeed.
I still get a lot of skepticism on software. That only makes me think the recent software rally has legs. Ultimately, price drives investing: if a FOMO rally kicks in, investors will have to reallocate to the sector.
Silverman: When the initial software selloff happened, the sector was compared to the newspaper industry in the internet era. But our study showed that from the late 90s, it took most of the newspaper companies until 2008 to be fully disrupted. There was a slew of M&A, and a lot of newspaper companies got taken out at premiums.
Fisher: Software bulls are probably wishing that this war will not end. The fear is, once the geopolitical stuff dies down, attention will come back to the secular issues around software.
Silverman: Before Iran became headline news, the IGV (iShares Expanded Tech-Software Sector ETF) and BDC (Business Development Company) constituents were all bottoming. Some would say that means we already had the drawdown, but that’s not necessarily true.
Even though we're getting a reprieve on the S&P side, skew hasn't budged all that much. It's the market's way of telling you that even though we might have some temporary relief, longer-term issues remain. In the IGV constituents, you are seeing the sentiment shift, but not so much yet in the BDCs.
What is the likely impact of the Iran war on the energy markets
Fisher: Some clients see the risk that we get a structurally higher floor on oil. The more bullish are saying that if Iran, which has been a bad actor for decades, can be removed, the longer-term picture will be a secular change for the good.
A lot depends on the duration of the war. If it persists, you start to worry about GDP getting hit, and then we start to get a growth scare and a real drawdown.
How are retail investors reacting to volatility?
Fisher: The retail investor has consistently, and shockingly to a lot of people, just bought the dip. No risk event seems to dissuade them.
Silverman: Retail has become the most stable leg of the stool. It’s similar to a company deploying a massive stock buyback. You've effectively cut off part of the tail, because you have someone who's supporting it, essentially through a put option. And this is what retail has become.
In terms of volatility, the risk is not that something scares away retail investors. It's that they might decide they want to play with something shinier instead.
I’m interested in how prediction markets start to influence options, which were the original prediction market. I think the options markets are going to start doing predictions – essentially, they'll do more binary options.
"The risk is not that something scares away retail investors. It's that they might decide they want to play with something shinier instead.”
Amy Wu Silverman, Head of Equity Derivatives Strategy
