We don’t write a lot about Brazil’s economy or their stock market because frankly we don’t know that much about either. What has stuck out to us in 2015 is that China has caught most of the attention as it relates to emerging markets, while Brazil and Russia’s economies and currencies have been in a tail spin but largely off the radar. Overnight S&P cut Brazil’s debt rating to junk causing the reverberations in their currency, debt and equity markets. All are down today.
Brazil’s largest equity index, the Bovespa opened down 2.5% (its futures were down a bit more in the overnight) but is now down only 50 bps. The largest trade in index etfs just went up in the EWZ (the iShares MSCI Brazil etf, which is down 34% on the year) When the etf was $23 (at 11:53am) a trader sold to close 34,000 Sept 26 puts at 3.10 and bought to open 40,000 Oct 22 puts for 1.01. This is a roll out (in time) and down (in strikes) and is likely a hedge. When you see this sort of activity it likely means an ongoing hedge given the continued commitment and the out of the money nature of the opening put purchase.
But a hedge against what? When you see put buying in an equity etf of a foreign index, the hedge could be part of a larger picture, where an investor is looking for the cheapest disaster hedge across asset classes. If the shit is about to hit the fan in Brazil, an equity collapse would be the last shoe to drop, spilling over from the credit and currency markets. But don’t extrapolate this sort of activity as an outright bearish commitment, especially in a risk asset that is at its 52 week lows, down 55% from its year ago highs. It’s likely against something.
Short dated implied volatility is up 100% in the EWZ from its 52 week lows made in late June, but the one year chart below shows it still well below its 52 week highs made last fall:
Now look at the 3 year chart of 5 yr Credit Default Swaps (CDS) on Brazilian debt, it’s up more than 200% in the last year:
As we’ve seen all over the place the past year, it’s only a matter of time before volatility in other asset classes eventually reach equities. And in times of crisis, savvy investors will seek out relatively cheap protection where it exists.