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There's a lot of risk priced in the markets: Kaiser

Stuart Kaiser, UBS Head of Equity Derivatives Research, joins Yahoo Finance Live to discuss the return of volatility around the vaccine and Georgia Senate runoffs, as well as some of his preferred trades in this landscape.

Video Transcript

JULIE HYMAN: I want to bring in Stuart Kaiser now. He is UBS head of Equity Derivatives Research. Stuart, we have talked a lot about the expectations around this runoff. And I'm curious how volatility is setting up ahead of it and then beyond it, going in, say, forward two weeks. And happy new year, by the way. Thanks for being here.

STUART KAISER: Happy new year. Good morning. In terms of volatility, about a week or two ago, the markets were pricing about a 2% move on the election runoff. That's come down to about 1 and 1/2%. And I think the reason there is because of the bipartisan stimulus deal that got announced.

The runoff, which I think kind of viewed as the positive if the Dems win would be more stimulus, and the negative might be more taxes and regulatory. And now that we've sort of had some of the stimulus get announced, that's taking a little bit of the bite out of the event, as it were. So about a 1 and 1/2% move price, which feels about right, maybe a touch high because this event has been so well-anticipated. But the fact that polls are showing about a 50-50 odds of the outcome is probably why that volatility is where it is.

Beyond the election, there's a lot of risk priced in the markets, and, frankly, a little bit more than we might have expected, given the type of news flow we got starting post-election. And I think you know the reasons for that are multiple. I think part of it is that there's some scar tissue from last year, really difficult risk here last year. So people are a little hesitant to be short any volatility.

And I think the second is the news flow on the vaccine over the last couple of weeks has definitely caught people's attention, starting with Pfizer maybe not getting as many doses prepared as they had hoped to the disease mutation to the slower vaccination pace, and now the full lockdown back in the UK. So I think in our view, the base case outcome is improved over the last couple of months. But the range of outcomes around that hasn't really narrowed that much. And for that reason, the volatility markets are pretty on edge about it.

BRIAN SOZZI: Stuart, with the-- with this return of volatility around the vaccine and the Georgia Senate runoff, what are some of your preferred trades? Have they changed relative to the last week of 2020?

STUART KAISER: Our view is that risk is probably priced a little bit too high relative to the outlook we have for economic growth, earnings growth, and vaccine rollout. So generally speaking, we would not be recommending owning a whole lot of options right now, just because the bar is set so very high that for you to make money owning options right now is tough. The VIX is 16 or 18 points higher than realized volatility. The level of implied volatility 3, 6, 12 months out is higher than 90% of months that we've seen over the last 80 plus years. So we've generally been of the view that if you're going to hedge, you need to do it in a very cost-managed way.

One thing we've actually liked is being short S&P 500 put options longer dated. And the logic there is just that given our view, that risk is priced very high. So if you were to sell let's say a 20% out of the money December 2021 S&P put, you generate almost 320 basis points, 3.2% yield, which is extremely high relative to where the dividend yield is and where corporate bond yields are.

So our view is if you're going to hedge, keep it very short dated. Focus on the S&P. Focus on high-yield credit. If you're looking at 6 to 12 months, we think the average on those options is very high. And we'd be either using lower-cost strategies or, frankly, being short some volatility further out the curve.

MYLES UDLAND: All right, you see the Opening Bell there on this Tuesday morning, Rush Street Interactive ringing the bell, not a SPAC. We have been tracking just how many SPACs have rang the bell down on the floor in recent days. Stuart, I want to pick up on something else you brought up in your note, which we were all reminded of in March quite abruptly, which is correlations. They all go to one in a crisis, and you've noted that they're quite high right now and suggest a more risk-off environment, perhaps, than maybe the popular narrative is suggesting, certainly looking at how the market finished last year and what expectations are. What does that say to you about the current setup, but maybe skittishness that's out there in the market?

STUART KAISER: Yeah, I think it says that we're not quite out of the woods. Clearly the news flow on the vaccine has been positive, right? The efficacies are extremely high. And you're already rolling out and vaccinating folks, which is-- which is hugely, hugely good news.

But on the flip side of that, this is an event that people just don't know how to handicap because they haven't been through it before. And the vaccine-- excuse me, the virus mutation, I think, has really caught a lot of people off guard a bit, because so many hopes have been pinned towards widespread vaccination and getting to a sort of a herd immunity level. And if this were to mutate in a way that the vaccine was less effective, you know that becomes a bit of a game changer.

And I think the second point is I think most investors hope that these broad-based kind of harsh lockdowns were behind us a bit. And seeing the UK go back to that type of lockdown, I think, does have people really worried about what the economic data is going to look like for the next one to three months. So I think you're seeing two things. I think you're seeing people worried about the near-term data, and then also at least risk adjusting a bit how bullish they were on the outlook just because of the degree of uncertainty the virus mutation has brought into the system.

And as a result, to your point, that's meant that assets are just moving together. The dollar is moving with equities is moving with rates is moving with credit. And that does tend to happen when the markets are quite unsettled and folks aren't focusing on asset-specific fundamentals.

So look, it's not the end all and be all for indicators. But I think the fact that volatility is high and correlations are high is telling you that the institutional investment community is still a little bit worried about the pace of things. And they're more than happy to leave just a little bit of extra risk premium in the system until they're proven incorrect.

BRIAN SOZZI: Stuart, are you see investors flock to in the early going here in the new year around any new trades, maybe some trades or some things that are not being talked about by the market right now, not black swan event type triggered events, but any type of new trades that you're seeing come on people's radar screens?

STUART KAISER: You know, I think one of the things is just the broad-based search for yield at this point. I think last year when you were very, very defensive and sort of hiding under the kitchen table, you weren't as much focused on going out the yield-- the yield term structure. So I think people are trying to find yield in any way they can. In equities that would be selling optionality, but also looking at other parts of kind of the credit market.

I think the second would be folks sort of taking a step out the risk spectrum in equities. So I think there's much more interest in investing in regions outside the US, Asia in particular, people also looking around-- around parts of developing Europe in the emerging markets. So I think now that the calendar's turned and people have a 12-month runway, you're seeing a little bit of a move up the risk curve in those areas as well. So I think-- I'm just saying those are mysterious trades. But I do think people are starting to kind of dip their toes into some trades that maybe ahead of year end, when they had a surprisingly decent year, they weren't really interested in engaging in.

JULIE HYMAN: Certainly the tone of the overall equity market feels a little bit different here as we start off the year. Stuart Kaiser, always great to see you. Happy new year again. UBS head of Equity Derivatives Research, thanks.