Silicon Valley Bank and Investors Consideration of Tail Risk

On Friday evening, I was talking to a friend who is a senior executive at a large commercial bank. He claimed that the fallout would be limited to SVB and a few similar banks. The people who would be hurt would be limited to the venture capital community as well as their tech portfolio companies, since both had significant deposits at SVB. He also said although he had spent the last few days reassuring customers, this was good for his firm, as people moved assets to his large, well capitalized bank.

So the question is why did the government orchestrate a bailout? We believe there are two reasons. First, the government has developed a culture of aggressive intervention since 2008. The precedent has been set, and there is now political pressure to act quickly when there are signs of distress as we have seen again and again. Secondly, policy makers realize that the financial system has been weakened by these multiple large interventions, so now even a small disruption has the potential to cause a chain reaction leading to chaos. This is particularly true at this point. 

After the underperformance of volatility in 2021, we believe market participants are largely unhedged, as evidenced by the low cost of deep out of the money options in protective asset classes (until the last few days).

So what is the takeaway for investors? In a few words, make sure you protect your portfolio against market panic. Dependent on your personal financial situation it may make sense to look at how tail risk exposure can mitigate risk associated with these extreme economic developments. Hedging ahead of time may make it so you are prepared for serious downturns in markets and can rest easy knowing you have proactively positioned to protect your capital.

The Ambrus Group is a volatility arbitrage firm with a focus on tail risk. Their goal is to protect their investors from large market crashes. The team leverages in-depth knowledge of derivatives, volatility, and market microstructure to help investors navigate financial markets. You can email The Ambrus Group here.