Options Traders Are Preparing for a Market Decline

Summary

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WSJ Your Money Briefing: “Options Traders Are Preparing for a Market Decline”

Date: December 19, 2019
Host: J.R. Whalen
Guest: Gunjan Banerjee, Wall Street Journal reporter

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Overview

This episode examines how options traders are bracing for a possible downturn in the markets, despite a strong end to 2019 characterized by record-breaking highs. Reporter Gunjan Banerjee discusses the motivations behind increased demand for bearish options, the factors traders are watching (especially the upcoming US presidential election), and what this hedging activity signals about investor sentiment heading into 2020.

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Key Discussion Points & Insights

1. Strong Market Performance & Cautious Sentiment

• The S&P 500 has risen over 25% in 2019, with US markets hitting new records.
• Amid the so-called “Santa Claus rally,” many investors are nonetheless preparing for a possible market pullback.
• Gunjan Banerjee points out that investors remember 2018, when late-year market gains evaporated in the fourth quarter.
  (02:05)

2. Potential Triggers for Volatility

• 2018 Repeat: Fears of another abrupt downturn similar to Q4 2018.
• 2020 Presidential Election: Seen as a major potential source of volatility.
  • “Next year we have a presidential election. Some investors are also viewing that as a potential source of volatility and looking to hedge their portfolios.” – Gunjan Banerjee, (02:20)
• Uncertainty Around Democratic Nominee: The business stance of the final candidate is of particular concern.

3. What Options Traders Are Doing

• Hedging Portfolios: Many investors are using options not just for speculative directional bets, but more for hedging.
• Spending on Protection:
  • “The cost of such protection, the cost of these hedges in the options market, is increasing. That tells us that there’s more demand for these bearish options.” – Gunjan Banerjee, (03:42)
• Bearish vs. Bullish Option Pricing:
  • Options traders watch the ratio of bearish (put) options prices compared to bullish (call) options. This ratio is currently elevated, reflecting anxiety.

4. Big Players Following the Trend

• Large institutions are participating; Bridgewater, one of the world's largest hedge funds, has placed a substantial bearish bet that pays if the S&P 500 falls by March.
  (04:11)

5. Is This a New Trend or Ongoing Shift?

• Demand for protective options has become more pronounced recently, especially as the S&P 500 reaches new highs.
• Banerjee observes that the options market is notably more cautious than the stock market right now.
  • “The options market is just a little bit more cautious about some of these recent optimistic developments than the stock market has been.” – Gunjan Banerjee, (04:53)

6. Bullish Bets Still in Play

• Not all option activity is defensive. Some traders are also buying bullish options, anticipating further market gains.
• Caveat: Hedging isn’t free—spending on protection can lead to losses if markets keep rising, as often happens.
  • “These types of portfolio hedges, yes, they can protect their portfolios from a downturn, but they cost money. They’re not free.” – Gunjan Banerjee, (05:21)

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Notable Quotes & Moments

• On 2018’s Volatility as a Cautionary Tale:
  “Some investors are concerned that we could see a redo of 2018... The S&P 500 was ascending through September and then it started to tumble in the fourth quarter.” – Gunjan Banerjee, (02:05)

• On Elections as a Volatility Trigger:
  “The election is at the top of their list.” – J.R. Whalen, (02:42)

• On Increased Costs for Bearish Protection:
  “The cost of bearish options relative to bullish options is elevated at the moment.” – Gunjan Banerjee, (03:42)

• On the Contrast Between Stock and Options Markets:
  “The options market is just a little bit more cautious about some of these recent optimistic developments than the stock market has been.” – Gunjan Banerjee, (04:53)

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Timestamps for Important Segments

• 02:05 – Fears of a 2018-style year-end market tumble
• 02:20-02:44 – How the 2020 election is weighing on investor sentiment
• 03:33 – Elevated activity and cost on protective option trades
• 04:11 – Example: Bridgewater’s high-profile bearish trade
• 05:21 – Balancing hedge spending with the risk that markets keep climbing

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Summary Takeaway

The episode spotlights the contrasting attitudes in the markets as 2019 ends: record stock highs are the backdrop for a quiet surge in options-based hedging. The main risks seen by traders are late-cycle market fatigue, the looming 2020 presidential election, and unresolved global risks (like US–China trade relations and Brexit). High-profile funds are betting on declines, and the cost of protection is up—yet the “fear” in the options market may serve as prudent caution rather than outright pessimism.
With both bullish and bearish bets on the rise, options traders are preparing for volatility in either direction, knowing that hedging comes at a real cost.

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Transcript

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[Consumer Advocacy Group Representative]

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[J.R. Whalen]

Here's your money briefing for Thursday, December 19th. I'm J.R. whelan at the Wall Street Journal in New York. The Santa Claus rally is in full force on Wall street, but many investors are prepared for what they see as an inevitable pullback. Wall Street Journal reporter Gunjan Banerjee will explain how options traders are prepared and they're spending billions to hedge against a market decline. First, some money in market news you should know. Cyber attacks over the summer targeted the payment systems on gas pumps in an attempt to gather personal data. And Visa sees that as enough of a threat. It issued a warning to merchants and the public. It says hackers exploited network weaknesses along the payment network. Now, the Consumer Federation of America says there isn't a way for consumers to spot and avoid compromised gas pumps, but drivers can always use cash to avoid risk. Plus, it's a good idea to check your credit card statement daily for unauthorized activity. The S&P 500 is up more than 25% this year, and US markets are closing out 2019, hitting new records. But what if that run came to a halt? Options traders are playing the market with that scenario in mind, and Wall Street Journal reporter Gunjan Banerjee is here to explain. So, Gunjan, let me play the market optimist here. We're hitting fresh records at least once a week, it seems. What could possibly go wrong?

[Gunjan Banerjee]

That's a really interesting question, and that's what a lot of people are wondering right now. You are seeing fresh records hit day after day. But I think some investors are concerned that we could see a redo of 2018. And what happened in 2018 was the S&P 500 was ascending through September, and then it started to tumble in the fourth quarter, and major indexes ended up in negative territory for the year. So some people are wary of a redo there. And then, you know, next year we have a presidential election. So some investors are also viewing that as a potential source of volatility and looking to hedge their portfolios.

[J.R. Whalen]

So the election is at the top of their list.

[Gunjan Banerjee]

Exactly. Yes.

[J.R. Whalen]

What do option traders see that a lot of other folks on Wall street do not? Aside from the election, what do they think could be potentially pulling the markets down in 2020?

[Gunjan Banerjee]

Options traders, they can use these types of contracts to make directional bets and profit from a quick rise or fall in the stock market, or they can use these types of contracts to hedge their portfolios. So many investors are also looking to the latter. We've seen these tremendous gains in the stock market. Let's try to make sure that we're protected against potential losses. And as you ment, the election could be one source of volatility. Some investors are closely watching who the final Democratic nominee will be for the US Presidential election, and especially that nominee's stances toward business.

[J.R. Whalen]

And the amount of trades by option traders to protect themselves against a fall that block, that amount of trades is actually fairly high.

[Gunjan Banerjee]

So what we're seeing is that the cost of such protection, the cost of these hedges in the options market is increasing. So. So that tells us that there's more demand for these bearish options that would protect investors from potential losses in their portfolio. And options traders closely watch a measure that gauges how expensive are these bearish options relative to the bullish options. And the cost of bearish options relative to bullish options is elevated at the moment.

[J.R. Whalen]

And there's some very prominent investors that have joined this trade in a big way.

[Gunjan Banerjee]

So the Wall Street Journal reported that Bridgewater, one of the biggest hedge funds in the world, has also put on a very large opt trade that would profit if The S&P 500 fell by March.

[J.R. Whalen]

So have you seen this options trading, this hedge against a decline in the markets? Has this been building up as the year has gone on, or are we seeing this triggered in just the fourth quarter?

[Gunjan Banerjee]

There hasn't been a definitive trend, but I've definitely been hearing more from investors lately that there seems to be more demand for hedges in the options market lately. And that's surprising to some investors because again, they see the S&P 500 at a record high. They see stocks soaring. And then on the other hand, the options market is sending a more cautious signal. And there you have investors saying, well, you know, the US and China, they reached a preliminary trade pact, but what if it doesn't last? Or we've had these developments on Brexit, but again, what if they don't last? So the options market is just a little bit more cautious about some of these recent optimistic developments than the stock market has been.

[J.R. Whalen]

Now, the market could continue to rise in 2020 are options traders in on that action as well?

[Gunjan Banerjee]

So some people have definitely also turned to bullish options that would profit if stocks continue to rise. And that's one thing that options traders need to keep in mind, because these types of portfolio hedges, yes, they can protect their portfolios from a downturn, but they cost money. They're not free. And what we've seen in recent years is often traders would pay up for these types of hedges only to lose money from them.

[J.R. Whalen]

All right. Options traders getting themselves ready for the new year. And that is Wall Street Journal reporter Gunjan Banerjee here in our studio. Gunjan, thanks for coming on the show.

[Gunjan Banerjee]

Thanks for having me.

[J.R. Whalen]

And that's your money briefing. I'm JR Whalen in New York for the Wall Street Journal.

[Small Business Owner]

Access to affordable credit helps me pay my employees, but I don't really need it.

[Retail Industry Representative]

Inflation is killing me, but who cares? Big retailers are making record profits. That's why we support the Durbin Marshall credit card bill.

[Small Business Owner]

See, banks and credit unions help small businesses make payroll. This bill would cut the vital resources

[Retail Industry Representative]

they need while increasing megastore profits. They deserve it, don't they?

[Consumer Advocacy Group Representative]

Tell Congress, stop the Durbin Marshall money grab for corporate megastores paid for by the Electronic Payments Coalition.