June 16 (Bloomberg) -- Investors should use options to bet that developed-market stocks will extend declines as the European Central Bank struggles to contain the region’s worsening debt crisis, MKM Partners LP said.
Jim Strugger and Etai Friedman, equity options strategists at the firm, recommended using iShares MSCI EAFE Index Fund options in a “put butterfly” strategy, selling two of the August $55 calls while buying one August $51 call and one August $59 call. The trade profits most if the ETF tracking 958 companies in Europe, Asia and Australia falls to $55. The U.S. ETF lost 3.3 percent to $58.29 yesterday, paring this year’s gain to 0.1 percent.
“Sovereign debt pressures in peripheral Europe continue to mount as the ECB proceeds with contracting its balance sheet,” the Stamford, Connecticut-based strategists wrote yesterday, when the ETF traded at $60.27. “These strains, coupled with our view that equities may be approaching a period of elevated volatility, lead us to believe that short directional exposure is warranted.”
Stocks tumbled around the world yesterday and the euro slid the most in more than a month amid rising concern that Greece will default and that Prime Minister George Papandreou will be forced out of office amid escalating protests over budget cuts. The cost of protecting corporate bonds soared to the highest level since January, with credit-default swaps anticipating about a 74 percent chance that Greece won’t pay its debts.
The strategists cited Michael Darda, MKM’s chief market strategist, who has said that the ECB’s monetary policy will “deflate its balance sheet, damping nominal GDP growth and further threatening the periphery even following drastic austerity measures and bailouts,” according to the report.
Europe’s benchmark gauge of stock-market volatility rose to the highest in three weeks today. The VStoxx Index, which measures the cost of protecting against a decline in shares on the Euro Stoxx 50 Index, increased 7.9 percent to 24.88 at 8:20 a.m. in London. The Euro Stoxx 50 stock index fell 1 percent to the lowest since December.
--With assistance from Liz Capo McCormick, Nikolaj Gammeltoft and Lu Wang in New York and Mark Gilbert in London. Editor: Andrew Rummer
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