Bloomberg News

Emerging Market Hedging Prices Jump on Europe Infection: Options

September 29, 2011

Sept. 29 (Bloomberg) -- The price of options to protect against losses on equities from China to India and Brazil has surged to its highest since 2009 relative to U.S. contracts.

The spread between implied volatility for three-month options on the iShares MSCI Emerging Markets Index and the SPDR S&P 500 ETF Trust has doubled to 13.19 this month. It reached 14.92 on Sept. 26, the highest level since June 2009, data compiled by Bloomberg show.

Investors are trying to lock in gains after the emerging markets gauge rallied 84 percent since March 9, 2009, beating the Standard & Poor’s 500 Index by 13 percentage points. They’re hedging even after Mohamed El-Erian of Pacific Investment Management Co., which runs the world’s biggest bond fund, said on Sept. 24 that emerging economies will “maintain faster growth” as the global economy slows.

“The fear of a second Lehman is clearly affecting all markets,” Schroders Plc’s Nicholas Field said in a Sept. 23 telephone interview, referring to the U.S. investment bank whose 2008 collapse sent global stocks plunging. He invests in emerging markets for London-based Schroders, which oversees $255 billion. “The more the fear persists and there is no resolution to the underlying issues in Europe, then the more selling of any risk assets will occur.”

Volatility gauges jumped globally last week as concern grew that global stocks may extend losses if Europe can’t contain its debt crisis. International Monetary Fund Managing Director Christine Lagarde said Sept. 23 that emerging markets aren’t immune to the challenges faced by major economies.

Rising Volatility

The VIX, as the Chicago Board Options Exchange Volatility Index is known, surged 33 percent last week, and declined 5.5 percent to 38.84 today, compared with a 21-year average of 20.45. The VStoxx Index, which measures the price of options to protect against Euro Stoxx 50 Index losses, jumped 13 percent last week and fell 4.2 percent to 44.44 today. The HSI Volatility Index, based on Hong Kong’s Hang Seng Index, climbed 29 percent last week and rose 2.3 percent today.

The MSCI Emerging Markets Index plunged 12 percent last week, the biggest drop since November 2008, and on Sept. 26 touched its lowest level in two years. Emerging markets stocks underperformed advanced-nation shares during times of financial stress that sparked global losses during the past two decades including Latin America’s “Tequila Crisis” in 1994 after Mexico’s peso devaluation and Russia’s default on $40 billion of debt in 1998.

Steeper Slumps

The peak-to-trough drop in the emerging-market index was 12 percentage points bigger on average during the six retreats, according to data compiled by Bloomberg. During the 2008 crisis, when the bankruptcy of Lehman Brothers Holdings Inc. spurred the worst contraction since the Great Depression, the emerging- markets ETF fell as much as 67 percent from its record, while the S&P 500 fund dropped up to 61 percent.

Implied volatility, the key gauge of options prices, for the emerging-markets ETF contracts expiring in three months jumped to 48.72 Sept. 23, the highest since March 2009. The S&P 500 fund’s implied volatility climbed to 34.29 the same day, the highest since April 2009.

“What’s taking the lead are fears about the macro-economic scenario, including risks of a global slowdown,” Patrick Legland, the Paris-based head of research at Societe Generale SA, said in a Sept. 23 telephone interview. “People are trying to protect themselves as much as possible, so they’re implementing hedging strategies.”

‘Catastrophic Risk’

U.S. Treasury Secretary Timothy F. Geithner warned at an annual meeting of the IMF in Washington on Sept. 24 that failure to combat the Greek-led turmoil threatened “cascading default, bank runs and catastrophic risk.” Growth in the world economy will be slow and downside risks are “piling up,” Lagarde said at the same meeting on Sept. 23.

Pimco’s El-Erian said last week in an interview from Washington that the worldwide expansion will be about 2.5 percent, less than the 4 percent IMF forecast for this year and next. The IMF on Sept. 20 lowered its projection from 4.3 percent for this year and 4.5 percent in 2012.

The MSCI Emerging Markets Index rallied 4.9 percent, the most since May 2009, on Sept. 27 after Greece made progress in meeting requirements for more international aid, and Germany vowed continued support for the country. The MSCI World Index of shares in developed nations posted a smaller advance, rising 2.8 percent.

Faster Growth

The IMF predicts growth of 6.4 percent in developing economies this year and 6.1 percent next year, down from 6.6 percent and 6.4 percent forecast in June. Richer nations will grow 1.6 percent this year instead of the 2.2 percent expected in June, and 1.9 percent next year instead of 2.6 percent, the IMF said.

Federal Reserve Chairman Ben S. Bernanke said yesterday that the U.S. should learn from the success of many emerging market economies and support strong economic growth through responsible fiscal policy.

“In the long run, you’ll get more growth in emerging markets than anywhere else,” Angus Tulloch, who helps oversee more than $40 billion as joint managing partner of the Asia- Pacific-GEM equities at First State Investments in Edinburgh, said in a Sept. 23 telephone interview.

Implied volatility for the iShares MSCI South Korea Index Fund rose to the highest level since March 2009 yesterday versus the ETF tracking the S&P 500. The spread between the iShares MSCI Brazil Index Fund and the U.S. ETF rose to the highest since May 2010 last week.

“‘Risk-off’ has never been good news for emerging markets,” Edward Chan, who oversees about $1 billion at Royal London Asset Management in London, said in a Sept. 23 telephone interview. “The biggest worry about Europe is, eventually, will there be a default? What are the implications on the European banks and indeed the global financial system? You can paint a scenario much worse than what we saw from Lehman. Lehman times two, times three.”

--With assistance from Michael Patterson, Jason Webb and John Glover and Agnieszka Troszkiewicz in London, Sho Chandra, Shamim Adam, Sandrine Rastello, Simon Kennedy, Gabi Thesing and Rich Miller in Washington, Sandrine Rastello and Sara Eisen in New York, Lilian Karunungan in Singapore, Fion Li in Hong Kong, Karl Lester M. Yap in Manila and Aki Ito in Tokyo. Editors: Joanna Ossinger, Nick Baker

To contact the reporter on this story: Cecile Vannucci in Amsterdam at cvannucci1@bloomberg.net

To contact the editors responsible for this story: Nick Baker at nbaker7@bloomberg.net; Andrew Rummer at arummer@bloomberg.net


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