The new year brought a fundamental market driver seldom seen in the world of finance: a global viral outbreak. The onset of the novel coronavirus, officially labeled COVID-19 by the World Health Organization (WHO), sent a shockwave through the equity, commodity, currency, and debt markets. Although the immediate reaction to the novel coronavirus was muted, the final impact was devastating.
For astute traders, using futures to hedge against risks posed by the coronavirus became a priority. Whether navigating the late-February stock market crash or commodity market volatility, futures were an ideal way of staying one step ahead of the erupting pandemic.
Market Impact of the 2020 Coronavirus Outbreak
When the coronavirus outbreak was confirmed on Jan. 7, 2020, its international impact was projected to be negligible. The Chinese government took aggressive steps to contain the virus, quarantining the origin city of Wuhan and surrounding areas. Unfortunately, the efforts proved ineffective. By the end of February, confirmed cases numbered more than 82,000 globally, with at least 2,800 fatalities.
During the lead-up to the Feb. 24 trading week, traders and investors addressed the COVID-19 outbreak with skepticism. Asset pricing volatility fell within “normal bounds,” and few professional traders thought of using futures to hedge their exposure. However, after reports of widespread breakouts in Iran, Italy, and South Korea became public ahead of the trading session on Monday, Feb. 24, the financial markets descended into chaos. Here are the key financial events that transpired between the Monday, Feb. 24 open and the Thursday, Feb. 28 close:
- U.S. equities dropped from near all-time highs into corrective territory. As of the Thursday, Feb. 27, 2020 Wall Street close, the Dow Jones Industrial Average (-2636.29, -9.3%), S&P 500 (-279.22, -8.5%), and NASDAQ (-618.63, -6.8%) all posted massive four-day losses.
- U.S. 10-Year Treasuries saw yields dip beneath 1.25% for the first time in history.
- April West Texas Intermediate (WTI) crude oil futures fell by more than $6.00 per barrel, beneath December 2018’s low ($45.92).
- Agricultural commodities struggled to find solid ground. Losses sustained in May corn (-12’6, -3.35%) and April live cattle (-7.775, -6.58%) paced the decliners.
- To most traders, using futures to hedge means buying gold. For this period of market tumult, the strategy proved ineffective. Although volatile, April gold futures traded largely flat (-0.60, -0.07%).
Using Futures to Hedge Against Coronavirus Fears
As the old saying goes, hindsight is 20/20. In the case of the panic-selling sparked by the COVID-19 epidemic, this is certainly true. However, using futures to hedge can help traders and investors proactively manage risk. Here are a few ways that futures could have been used to protect market share amid the coronavirus outbreak:
- Equities: Futures products offer an abundance of options in the arena of portfolio diversification. For instance, opening a short position in a deferred-month Micro E-mini or E-mini S&P 500, Nasdaq, or DOW futures contract greatly limits exposure to downside risk. In the event of a coronavirus-type stock market plunge, gains generated from active shorts may be used to offset losses taken by traditional equities positions.
- Agricultural commodities: A good marketing plan includes a strategy to manage unforeseen risk. In the case of corn or live cattle producers, the COVID-19 outbreak brought an abundance of weakness to asset pricing.
For U.S. corn producers, selling harvest-time September or December corn futures contracts provides insulation from catastrophe. Cattle producers deal with a more complex scenario. However, limiting the fallout from the coronavirus was as simple as selling June, August, or October live cattle futures.
Active shorting is only one way of using futures to hedge against downside pricing risks. There are countless others, each designed to protect your hard-earned wealth from the unknown.
Be Ready for Anything with Daniels Trading
The novel coronavirus has been a primary driver of recent market volatility, but the event wasn’t entirely without precedent. Since 2000, disease outbreaks such as Ebola, SARS, and avian influenza have impacted the markets in one way or another. Although rare, these events have and will continue to happen.
To learn how to navigate turbulent markets successfully, schedule your free consultation with a Daniels Trading futures expert today. Featuring decades in the industry, the team at Daniels Trading has the experience and competency to help you weather any financial storm.