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Options and Arbitrage Funds Become the New Hedge for Investors

“Investors are seeking new defenses against possible falls in European stocks as indexes plateau near multi-year highs and traditional hedges prove ineffective in a market anesthetized by near-zero interest rates.

These alternative tools range from option strategies aimed at minimizing the cost of holding a hedge to investing in funds which aim to generate some returns irrespective of the stock market’s direction, such as arbitrage hedge funds.

A 50 percent rally in European shares over the past two years has left investors fretting about high valuations and seeking to protect their gains against a possible selloff.

However, hedging tactics which worked during the jittery days of 2008 and 2011, such as straight bets on rising volatility, have proved inadequate in the current, becalmed market conditions, leading fund managers to look for alternatives.

“A direct exposure to volatility may hurt investors because volatility can still fall or stay at a low level for a long period of time,” said Bruno Pannetier, chief investment officer of London-based hedge fund Old Park Capital. “Investors have to find new ways of hedging.”

Hedging equity positions via futures on the Euro STOXX Volatility index, which gauges the prices of options on eurozone blue-chips and tends to move inversely to cash equities, has cost investors dearly over the past two years.

Firstly, the VSTOXX has fallen roughly 65 percent since the Federal Reserve and the European Central Bank made plain in 2012 that they were prepared to pursue radical measures. The index has shown no sign of revival because the magnitude of swings in the Euro STOXX 50 index has been even lower than option prices imply.

Furthermore, since futures with longer-dated maturities tend to be more expensive than shorter-dated ones at times of low volatility, investors would often have to stump up when selling an expiring contract to buy a new one.

To reduce this cost…..”

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