Bloomberg News

VIX Traders See Gain Erased as Futures Exceed Average: Options

September 28, 2011

Sept. 28 (Bloomberg) -- The biggest three-day rally in a month for the Standard & Poor’s 500 Index is failing to convince U.S. options traders to lower their guard against more losses.

Futures on the VIX show investors expect the Chicago Board Options Exchange Volatility Index to remain at least 50 percent above its historical average of 20.45 through May, data compiled by Bloomberg show. The VIX slid 3.4 percent to 37.71 yesterday, while May futures fell 1.1 percent to 32.15. The S&P 500 climbed 4.1 percent between Sept. 22 and yesterday.

The cost of options to protect against equity-market declines remains elevated even as shares reflect optimism that European leaders will tame the region’s debt crisis. Insurance against 10 percent losses in the S&P 500 has surged to the highest levels since May 2010, and the pricing difference between U.S. and European options has narrowed.

“Even though there’s some good news coming out of Europe, the problems of the world economic system have not been solved,” Joshua Parker, who oversees almost $400 million in options and stocks at Gargoyle Asset Management LLC in Englewood, New Jersey, said in a telephone interview yesterday. “Until the world economic system is stabilized, and that’s not going to take place overnight, we’re going to see volatility.”

The S&P 500 has rallied as U.S. Treasury Secretary Timothy F. Geithner and other foreign leaders apply pressure on Europe to address the debt crisis that’s driven Greece toward default. While the VIX has fallen, it remains above 37, a closing level reached during only seven periods since 1997.

Greek Vote

Equities advanced worldwide yesterday after Greek Prime Minister George Papandreou won a vote in parliament on a new property tax, bolstering his chances of pushing through austerity cuts aimed at securing further international financial aid for the country.

The VIX advanced 8.9 percent to 41.08 today as the S&P 500 reversed earlier gains to drop 2.1 percent, the most in a week.

Implied volatility for S&P 500 contracts betting on 10 percent losses has risen 11.74 points higher than calls wagering on 10 percent gains, according to data compiled by Bloomberg. That compares with the 15-month high of 12.33 points set on Aug. 24 for the pricing difference known as skew. Swings in the stock market have widened, which may drive options prices higher. S&P 500 realized volatility for the past 60 days is 34.65, its highest level since June 2009.

Bear Market

The MSCI All-Country World Index of shares in 45 nations extended its slump since May 2 to more than 20 percent last week, meeting the definition of a bear market, after credit- default swaps showed investors see an almost 100 percent chance Greece will be unable to repay its debt within five years. Benchmark measures for 32 out of 45 nations in the index also reached that threshold as of Sept. 23, and 18 of the 20 markets with the biggest losses from their peaks were European, data compiled by Bloomberg show.

“You have all of Europe looking to implode, a significant chance of a double-dip recession and any number of things spooking the market right now,” Dominic Salvino, a Chicago- based specialist at Group One Trading, the primary market maker for VIX options, said in a telephone interview yesterday. “These are long-term problems that will have to play out over months, if not years.”

Yesterday’s rally was spurred in part by cheaper valuations luring investors back to stocks, according to Wayne Wilbanks, chief investment officer at Wilbanks, Smith & Thomas in Norfolk, Virginia, which manages about $1.8 billion.

“The lack of negative news is enough” to prompt a rebound in stocks, he said yesterday in a phone interview. “The bears can get as bearish as they want to, but eventually they’ve got to say stocks are too cheap.”

Price to Book

S&P 500 shares traded yesterday for 1.92 times book value, or assets minus liabilities, according to data compiled by Bloomberg. The valuation sank to 1.83 on Aug. 8, the lowest since the month the bull market began in 2009. Before Lehman Brothers Holdings Inc. filed for bankruptcy in 2008 and intensified the financial crisis, the valuation hadn’t fallen below 2 since at least 1995, the data show.

Since the benchmark gauge for U.S. equities retreated to less than 1,250 on Aug. 4, it has traded between 1,119.46 and 1,218.89 on a closing basis. The measure rose 1.1 percent yesterday to 1,175.38.

“Everyone thinks we’re in a range between 1,100 and 1,225,” Jonathan Bensimon, head of equities and derivatives trading for the Americas at Societe Generale SA in New York, said in a telephone interview yesterday. The 1,200 level is “when people start to want to get short or at least buy puts, so that pushes volatility up.”

Trimming Gains

The S&P 500 advanced as much as 2.8 percent yesterday before paring its gain in the last hour of trading, following a Financial Times report that some euro-area countries are demanding private creditors take bigger writedowns on their Greek bond holdings.

“Politicians keep kicking the sovereign debt can down the road,” Nelson Saiers, chief investment officer of Alphabet Management LLC, said in an e-mail yesterday. The New York-based volatility hedge fund manages about $635 million. “The bid in back-month VIX futures just reflects that.”

Six-month VIX futures exceeded 33 on Sept. 22, a level seen during two periods since the contracts began trading seven years ago: between October 2008 and May 2009, and the middle of 2010, according to data compiled by Bloomberg.

The VStoxx Index, which measures the cost of protection against losses in the Euro Stoxx 50 Index, rose 1.9 percent to 46.39 today. The VIX last week eliminated more than half its discount to the VStoxx as traders bet Europe’s debt crisis will engulf the U.S.

Six-Month Contracts

Implied volatility, the key gauge of options prices, is rising faster for longer-term S&P 500 contracts than it is for those expiring sooner as investors pay more to protect stocks into 2012 and 2013. The level for six-month S&P 500 contracts has risen 10 percent from a month ago to 29.97, while one- and two-year options both increased at least 8.3 percent, Bloomberg data show. That compares with a 5.3 percent gain for 30-day options over the same period.

“Investors don’t buy this rally,” said Steve Kilcullen, head of flow derivatives sales for the Americas at Nomura Holdings Inc. in New York. “If they did believe it, they would be selling short-dated volatility much more aggressively because they’ve already gotten burned once.”

--With assistance from Kaitlyn Kiernan in New York. Editors: Joanna Ossinger, Nick Baker

To contact the reporters on this story: Jeff Kearns in New York at; Cecile Vannucci in Amsterdam at

To contact the editors responsible for this story: Nick Baker at; Andrew Rummer at

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