Stock-Market Volatility Bets at Record Amid Fed Tapering Fears

Wednesday, 12 Jun 2013 10:45 AM

 

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Widening swings in U.S. shares have prompted options traders to make unprecedented bets on equity volatility, pushing bullish and bearish contracts to records amid concern the Federal Reserve will curtail stimulus.

Options outstanding on the iPath S&P 500 VIX Short-Term Futures ETN, tracking a gauge of VIX futures, climbed to an all- time high of 3.46 million on June 6, based on data compiled by Bloomberg. The Chicago Board Options Exchange Volatility Index, a gauge of derivative prices for the Standard & Poor’s 500 Index, has gained 51 percent since a six-year low in March.

Investors are using contracts on the VIX note to hedge stock-market swings as they look for clues in economic data and statements from policy makers on whether the Fed’s bond purchases will be maintained or reduced. The S&P 500 has risen or fallen more than 1 percent four times during the past 10 days, the most in a month.

“These spikes before large economic events are becoming much more common now because all eyes are on the Fed,” Stephen Solaka, who oversees about $75 million including options as co- founder of Belmont Capital Group in Los Angeles, said by phone. “You have people playing both sides of these events for large up or down moves in volatility.”

The VIX jumped 7.6 percent to 17.50 on June 5 as a jobs report from ADP Research Institute and factory data missed estimates. The gauge tumbled 9 percent two days later after stocks rallied on employment data from the Labor Department that beat economists’ estimates.

Outstanding Options

The number of outstanding options on the VIX ETN, the most- traded security tracking volatility in the U.S., has risen 13 percent since the May 17 expiration. Daily volume in the ETN averaged 48.2 million during the past 30 days, compared with 15 million a year ago.

The S&P 500 is down 2.6 percent from a May 21 record on concern the Fed will consider withdrawing stimulus that has helped lift the index up 140 percent since March 2009. A survey of economists showed last week that the policy makers will trim bond purchases to $65 billion a month from the current $85 billion at the Oct. 29-30 meeting of the Federal Open Market Committee, according to the median estimate.

The U.S. volatility index increased 11 percent to 17.07 Tuesday. The gauge is still 16 percent below its 23-year historical average of 20.32. Its European counterpart, the VStoxx Index, lost 1.5 percent to 20.68 at 9:45 a.m. in Frankfurt after climbing 7.2 percent Tuesday.

Calls, Puts

The number of outstanding calls on the Barclays Plc’s iPath volatility exchange-traded note jumped 25 percent to 1.01 million since the May 17 options expiration, data compiled by Bloomberg show. During that time, put open interest increased 7.6 percent to 2.04 million.

All 10 most-owned contracts on the ETN were puts.

Equity volatility may be subdued in the coming months as steady earnings growth supports stock prices, according to Giri Cherukuri, head trader and portfolio manager at Oakbrook Investments LLC. Profits for companies in the S&P 500 will rise 6.6 percent this year and 11 percent next year, according to analysts’ estimates compiled by Bloomberg.

“You have on the one hand economic growth, which needs to pick up, and then you have on the other hand the Fed stimulus, which needs to slow down,” Cherukuri said in a phone interview from Lisle, Illinois, where he helps manage $3.5 billion. That will help “the market while keeping volatility down,” he said.

Short Selling

Investors boosted bets that volatility will decrease after the bull market entered a fifth year with the S&P 500 surging 14 percent in 2013. Short selling, the practice of selling borrowed stock on hopes the price will decline, rose to 18.7 million shares on June 10 from 7.7 million at the end of 2012, according to London-based research firm Markit.

Fed Chairman Ben S. Bernanke said during a response to questions following congressional testimony on May 22 that the central bank could consider reducing the monthly Treasury and mortgage debt purchases within “the next few meetings” if officials see signs of sustained improvement in the labor market. Philadelphia Fed President Charles Plosser has called for tapering the stimulus as soon as the central bank’s next meeting on June 18-19.

“Investor concerns of Fed tapering are considerably higher than anytime else in 2013,” Scott Maidel, who helps oversee more than $173 billion as an equity-derivatives money manager at Russell Investments in Seattle, said in an interview. “Longer-dated volatility hedging using futures and options is picking up.”

© Copyright 2014 Bloomberg News. All rights reserved.

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