Bloomberg News

VIX Futures Collapse as Bets Disappear on Rise Above 30: Options

November 01, 2011

Oct. 28 (Bloomberg) -- Futures tied to investor expectations for stock swings next year are posting record declines after European leaders agreed on a plan to contain the region’s debt crisis.

The average price of contracts on the Chicago Board Options Exchange Volatility Index for March through June plunged 8.7 percent in the past two days, the biggest drop on record, according to data compiled by Bloomberg. VIX futures of all maturities fell below 30 yesterday, the first time that’s happened since Aug. 17, the data show.

Speculation European leaders were moving closer to solving their debt crisis pushed the VIX to the lowest level in almost three months yesterday. While the benchmark measure of U.S. equity options has closed below 30 twice in the past two weeks, yesterday was the first time futures traders bet the index wouldn’t go back above that threshold in the next eight months.

“The No. 1 concern has been whether there will be contagion and whether Greece’s problems would spill over into Italy, Spain or Portugal,” Alex Tedder, who helps manage about $13.5 billion in global stocks at American Century Investments in New York, said in a telephone interview yesterday. “The measures announced overnight may have succeeded in ringing Greece to make sure contagion doesn’t happen. In that context, the trends in the VIX make sense.”

The VIX sank 15 percent to 25.46 yesterday and slipped 3.7 percent to 24.53 today. It peaked at 48, its highest level since March 2009, on Aug. 8 following Standard & Poor’s decision to strip the U.S. of its AAA rating.

Europe’s VStoxx Index tumbled 20 percent yesterday, the biggest slide in 17 months, to 30.34. The measure of Euro Stoxx 50 Index option prices gained 3 percent to 31.24 today.

50% Losses

The Standard & Poor’s 500 Index rose 3.4 percent yesterday after European leaders persuaded bondholders to take 50 percent losses on Greek debt and a report showed the U.S. economy grew at a 2.5 percent rate in the third quarter, the fastest pace in a year. The stock index has gained 14 percent in October, the biggest monthly advance since 1974.

Futures on the VIX expiring between five and eight months from now had an average price of 28.14 yesterday, 8.7 percent less than on Oct. 25, according to Bloomberg data. That’s the biggest two-day decline since at least 2005, the data show.

The most-active VIX options yesterday were November 25 puts, which accounted for almost one-tenth of the 938,385 contracts that changed hands. Those options more than tripled to $1.80. November 21 puts jumped sixfold to 30 cents for the largest gain among all VIX options.

‘Tail Risk’

“We’ve had a tail-risk event hanging over the market,” Michael Schmanske, head of U.S. equity index volatility trading at Barclays Plc in New York, said in a telephone interview yesterday. “This solution from the European governments is by no means a magic bullet nor does it truly solve the sovereign debt issues. However, it does remove the tail risk for the next three to six months.”

This week’s agreement doesn’t mean Europe’s leaders have ended the crisis, which still may reduce economic growth and corporate earnings, according to John Teahan, who helps oversee about 1 billion pounds ($1.6 billion) in stocks and options at RWC Partners Ltd. in London.

“As you go further out there’s more uncertainty, and that’s reflective of the increased risks in Europe,” he said in a phone interview yesterday. “Good news came out, but is that the end of that story? Absolutely not.”

VIX futures remain elevated compared with the gauge’s historic average. December contracts trade at 25.80, which is 26 percent higher than the 21-year average for the VIX over its 21- year history, Bloomberg data show. Before yesterday, the VIX hadn’t closed below that level for almost three months.

Market Tension

A gauge of banks’ reluctance to lend has widened to the most since July 2009, a sign that market tensions remain elevated. The dollar Libor-OIS spread was 34.31 basis points yesterday, more than double the 17.07 average over the past year, according to data from the British Bankers’ Association.

Europe’s economy will expand by 1 percent next year, according to the median economist estimate in a Bloomberg survey. That estimate is down from this year’s peak of 1.9 percent in February and 1.7 percent three months ago. Analysts have cut their 2011 earnings estimates for Stoxx Europe 600 Index companies by 5.7 percent since the end of July, more than the 0.4 percent drop in estimates for S&P 500 firms.

“Europe is probably going to go into recession,” Alec Levine, an equity derivatives strategist Newedge Group SA in New York, said in a telephone interview yesterday. “People are skeptical of this move because, while equity markets have embraced the European solution, credit markets have not embraced that optimism to the same degree.”

Lower Volatility

Implied volatility, the key gauge of options prices, for S&P 500 contracts expiring in three months tumbled 40 percent from Oct. 3, when it touched its highest level in 2 1/2 years. It fell to 21.91 yesterday, its lowest level since Aug. 3.

The S&P 500’s October 1,295 calls surged 33-fold yesterday to $5, the largest increase among all contracts linked to the benchmark index of American equities. October 1,300 calls jumped 30-fold to $2.10 for the next biggest gain. The S&P 500 hasn’t closed above that level for three months.

While the volatility futures remain elevated, contracts posted record drops as stocks rallied around the world. March VIX futures declined 8.7 percent yesterday to 27.30, for the biggest decline since those securities began trading in July. The April futures dropped 8.3 percent to 27.70, the lowest since they were first listed on the CBOE Futures Exchange in August. All futures fell at least 7.5 percent.

“These are big, big moves for the back-month futures,” Dominic Salvino, a specialist on the CBOE floor for Group One Trading, the primary market maker for options on the index, said in a telephone interview. “The market’s feeling that a certain level of risk in the market at least has been removed.”

--With assistance from Kaitlyn Kiernan, Whitney Kisling and Joanna Ossinger in New York. Editors: Nick Baker, Chris Nagi

To contact the reporters on this story: Jeff Kearns in New York at jkearns3@bloomberg.net; 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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