As the VIX retraces at a record pace, Bank of America (NYSE:BAC) said in a note Tuesday that investors may be tempted to breathe a sigh of relief.
However, the bank questioned whether the coast is really clear just yet.
Analysts at BofA explained that after the volatility spike on August 5, the VIX rapidly stabilized, dropping back to its pre-August year-to-date average level in just seven days—a record-setting retracement.
"The speed of this retracement has been historic, with the VIX dropping from its peak to below its long-term median in just 7 days (fastest in history)," the bank stated.
Despite the sharp recovery, Bank of America warns that numerous risks, ranging from macroeconomic to political and seasonal factors, still loom on the horizon.
With volatility back to relatively low levels and equities resuming their rally, the analysts at BofA believe that hedging the downside remains a prudent strategy.
They suggest leveraging S&P put spreads, which take advantage of lower volatility and recent steepening of skew, potentially offering a "7x+ payout" if optimism fades.
Furthermore, Bank of America says investors could explore fixed-strike hedges that could be further cheapened by leveraging the election risk premium in the VIX term structure.
Bank of America also notes that the current market presents a "favorable correlation entry point," motivating the use of S&P-rates hybrids for those concerned about "high-for-longer" risks.
It is said that these hybrids could be particularly useful if the Federal Reserve under-delivers on rate cuts amid persistent macro uncertainty.
While the rapid retracement of the VIX might suggest that the worst is over, Bank of America believes that the prudent approach is to stay hedged against potential downside risks as fall approaches.