Implied Volatility in Equities

While I do acknowledge that implied volatility in equity markets has come down quite a bit since the heady days of November, compared to any other point in history it remains at elevated levels. Perhaps one reason for this phenomenon is that insurers are getting an ugly wake-up call with respect to the risks they have been carrying on their books. Note the comments by Peter Rubenovitch, CFO of Manulife, which make it unlikely for volatility to ratchet down.

For the investor/trader who has risk capital to play with, one can create excellent breakeven strategies on the downside using 1x2 put strategies. For example, I looked at the following 3 structures (note that with yesterday's rally it has moved away from these levels slightly):

1. Buy the April 725-675 1x2 put spread for a credit of 13 - this creates a breakeven of 612 by mid-April
2. Buy the June 675-600 1x2 put spread for a credit of 5, which has a mid-June b/e of 520
3. Buy the December 550-460 1x2 put spread for even with a breakeven of 370

Admittedly, I would not bother with the third option as the expiry is too far away, and time decay does not really kick in to high gear until the last few weeks prior to expiry, but I found #1 extremely attractive especially given my/Ritholtz's view that we were due for an oversold bounce. Now I look for a trade up to 740 in S&P before we run into selling pressure.

Note also that while breakeven trades may appear very attractive there is huge mark-to-market (MTM) risk, and one must be prepared to deal with those consequences.

Finally, I intend to post further comments to Peter Rubenovitch's statement but I am still shell-shocked by the idea that an insurer would conciously retain the risk on such volatile exposure.