Investors are too bearish on Russian equities and should bet on a rally using options as Vladimir Putin will probably win the presidential election and implement reforms to stay in power, according to Societe Generale (GLE) SA.
The ratio of outstanding put options to sell versus calls to buy the Market Vectors Russia exchange-traded fund, a U.S.- traded fund that holds Russian shares, ended yesterday at 1.72- to-1, near the 1.93 multiple reached on Feb. 17 that was the highest level since Sept. 7, 2010, data compiled by Bloomberg show.
Prime Minister Putin will win on March 4 with 16 percentage points more than is needed for victory in the first round, according to a poll by the independent Levada Center. Russian stocks (RSX) will probably rally, so investors should be selling puts and using the proceeds to buy calls, said Rebecca Cheong, a New York-based equity derivatives strategist at Paris-based SocGen. Futures (VEA) expiring in March on Moscow’s RTS index gained 0.9 percent to 173,920 in U.S. trading yesterday.
“It’s not a bet on whether he will win, it’s what will be the market’s reaction to Putin winning,” Cheong said by phone on Feb. 29. “He’s going to do a lot more reform-friendly policies.”
The Market Vectors ETF and the Bloomberg Russia-U.S. 14 Index (RUS14BN) of Russian companies traded in New York had their biggest drop in two months in December as protesters took to the streets against results of a parliamentary election that saw Putin’s party retain its majority amid allegations of vote fraud. The former KGB officer gave up the presidency to Dmitry Medvedev in 2008 because of a constitutional limit on serving more than two consecutive terms.
The ETF jumped 1.2 percent to $33.41 in New York yesterday and has advanced 25 percent this year, after slipping 30 percent in 2011. The fund’s holdings include American depositary receipts of OAO Gazprom, Russia’s biggest company and the world’s largest natural gas producer, top lender OAO Sberbank and OAO Mechel (MTLR), the nation’s biggest producer of coking coal for steelmakers.
Barring allegations of widespread fraud or violence, a first-round victory by Putin will boost equities, said Komal Sri-Kumar, chief global strategist at Los Angeles-based TCW Group Inc., which oversees about $120 billion in total assets. Almost all of the demonstrations against Putin since the Dec. 4 Duma vote have been peaceful with few arrests. An opposition rally is scheduled for March 10.
“Once this election hurdle is past, that alone will increase the valuations of Russia relative to other European countries,” Sri-Kumar said in a phone interview on Feb. 28. “If the win is on the first round, I expect both the Micex and the RTS indices to rise sharply when the markets open Monday in Moscow.”
The RTS Index added 0.2 percent to 1,726.78 in Moscow yesterday.
The dollar-denominated gauge may climb to 2,500 by the end of the year should the government under a Putin presidency implement “radical reform” such as fresh Duma elections, the removal of privileges for favored companies, and fiscal changes that would allow the budget to balance below $100 a barrel, Kingsmill Bond, chief strategist at Citigroup Inc. in Moscow, wrote in a Feb. 27 research note.
“Incremental reform” would push the RTS to 2,000, while a crackdown on protesters and the media amid rising government spending could drag the RTS down to 1,500, Bond said.
“We believe that the market is too phlegmatic about the risks around the election as it continues to be lifted by rising oil prices,” he wrote in the note.
United Co. Rusal (486), the world’s largest aluminum producer, rose 2.6 percent to HK$6.82 in Hong Kong trading as of 11:18 a.m. local time. The MSCI Asia Pacific Index gained 0.3 percent today after U.S. jobless claims fell and European leaders agreed to speed up providing a permanent bailout fund for the region’s debt crisis.
The Bloomberg Russia-U.S. 14 index gained 1.2 percent to 114.29 yesterday, the biggest one-day advance this week. The RTS Volatility Index (RTSVX), which measures expected swings in the index futures, fell for the first time in five days, sliding 0.5 percent to 33.04.
Crude settled 1.7 percent higher at $108.84 a barrel on the New York Mercantile Exchange yesterday, after topping $110 for the first time since May. An Iranian state-run news channel reported an explosion at a pipeline in Saudi Arabia. A Saudi official said no oil facilities were sabotaged.
Cheapest Emerging Market
OAO Rostelecom (ROSYY), Russia’s biggest fixed-line telephone company, had the biggest drop on the Bloomberg Russia-U.S. 14 measure yesterday, widening the discount to its Moscow-listed shares to 1.6 percent, the most since Feb. 13. The company’s ADRs slid 1.7 percent to $29.65 after Rostelecom’s board approved buying the stake in pay television operator National Telecommunications that it didn’t already own.
Moscow’s ruble-denominated Micex Index (INDEXCF) trades at the lowest valuation of the 21 emerging markets tracked by Bloomberg, because of the “risk premium” investors associate with the nation’s assets, according to Lewis Kaufman, a Santa Fe, New Mexico-based money manager at Thornburg Investment Management, who oversees the Thornburg Developing World Fund (THDAX) and helps manage $79 billion.
The 30-stock Micex, which was little changed at 1598.83 yesterday, trades at 6.3 times analysts’ earnings estimates for member companies. That’s cheaper than Hungary at 9.4 times, Turkey at 9.6 and Egypt’s multiple of 8.4. Gazprom (OGZPY) ADRs trade at 3.6 times reported earnings, compared with 5.9 for London-based BP Plc and 12.4 for PetroChina Co. Ltd, data compiled by Bloomberg show.
“The lack of transparency in corporate governance, the corruption, will look very much the same post-election as it did pre-election,” said Kaufman, whose Developing World Fund is made up of about 10 percent Russian stocks. “The risk premium will remain elevated even in the event of a decisive Putin victory.”
Russia is viewed as the world’s most corrupt major economy, according to Transparency International’s 2011 Corruption Perceptions Index, with higher levels of perceived graft than Pakistan, Cameroon and Niger. Oil and natural gas sales contributed almost 50 percent of Russian government revenue last year, and make up about 17 percent of gross domestic product, according to official estimates.
Putin, who has promised during campaigning to reverse “repressive” state policies and protect private business, needs to strengthen investor protection, lower taxes on the energy sector and raise dividends at state-controlled companies to make the nation’s stocks more attractive to foreign investors, said Neil Wedlake, an eastern Europe equity strategist at Barclays Capital in London.
Lukoil Shelves Plans
“If Putin were to receive a strong majority vote, one would expect less political or economic reform, whereas it’s more likely we’d see a shift in policy if he were forced into a second round,” Wedlake said in an interview on Feb. 29.
OAO Lukoil (LUKOY), Russia’s biggest non-state oil producer, gained 0.9 percent to $64.30 in U.S. trading yesterday, reaching the highest level since Aug. 2. The ADRs ended the day 0.5 percent above Lukoil shares listed on the Micex. The company’s Moscow- listed stock fell 0.3 percent to 1,870.50 rubles, or the equivalent of $64.06. One ADR equals one ordinary share.
Lukoil shelved a plan to make a $1.8 billion shale acquisition in the U.S. because of slumping natural-gas prices, Deputy Chief Executive Officer Leonid Fedun said in an interview in London yesterday. U.S. natural-gas prices slumped 55 percent between June and January.
Traders should sell May $26 put options and buy $36 calls for the same month on the Market Vectors Russia ETF, according to SocGen’s Cheong. Implied volatility, the key gauge of options prices, for three-month contracts closest to the fund’s price has fallen 43 percent since an Oct. 4 high to 34.4 yesterday.
The 13 percent advance in the price of oil, Russia’s biggest export earner, since the start of February may also stoke gains in Russian stocks, Cheong said. Urals crude, Russia’s chief export blend and biggest export earner, climbed to a 3 1/2-year high of $125.26 a barrel yesterday.
Options are contracts that give the right, though not the obligation, to buy or sell a security at a set price and date. Calls give the right to buy a security for a certain amount, the strike price, by a set date. Puts convey the right to sell. Investors use options to guard against fluctuations in the price of securities they own, to speculate on share-price moves or to bet that volatility, or stock swings, will rise or fall.
A Putin victory is no guarantee of stability for Russia, said Alexander Muromcew, who manages $500 million in emerging- market stocks, including Russian investments, at TIAA-CREF. The protests following the Duma elections in December were the largest in Putin’s 12 years in power.
“It could be a risk that Putin wins and yet there’s still dissatisfaction among the urban middle class,” Muromcew said by phone on Feb. 29. “They could continue to protest when the election is over.”
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