U.S. stocks and the price of protection against losses are rising in unison more frequently than at any time since 1996, as investors anticipate the end of the biggest Standard & Poor’s 500 Index rally in two decades.
The Chicago Board Options Exchange Volatility Index and S&P 500 increased together on 23 percent of days in January and February, the most during those months in 16 years, according to data compiled by Bloomberg. In the 22-year history of the VIX, as the options gauge is known, the two indexes climbed at the same time on only 12 percent of days, the data show.
While the VIX dropped to a seven-month low of 16.80 on Feb. 23 as the S&P 500 posted its best annual start since 1991, traders have struggled to value risks amid concern stocks will drop, according to Dominic Salvino of Group One Trading and BMO Capital Markets Corp.’s Max Breier.
“People are still cautious,” said Peter Vance, who helps oversee $2.3 billion including options as a senior money manager at Whitebox Advisors LLC in Austin, Texas. “Volatility is quick to tick up on news events even as people are getting more comfortable with equities and putting risk on. At the back of investors’ minds there’s still the 2008 crisis and the risk of a European collapse.”
The VIX has declined 26 percent this year to 17.29, or 16 percent below the 22-year average, as the S&P 500 advanced 8.9 percent after the U.S. unemployment rate and jobless claims fell to levels last seen in 2009 and 2008, respectively. At the same time, there are signs investors are preparing for a higher VIX should attempts to calm the European debt crisis fail.
Its ratio to the so-called 20-day historical volatility of the S&P 500 has risen to 2.4 and reached 2.67 on Jan. 31, the biggest multiple since January 2011.
Traders are pricing in the biggest increase in U.S. equity hedging costs since 2010. April futures on the VIX settled at 23.70 on March 2, or 6.41 points higher than the level of the gauge, according to data compiled by Bloomberg. The gap widened to 7.02 points on Feb. 17. The last time two-month futures were that high in relation to the VIX was July 2010.
Traders protecting against declines in the S&P 500 created so much demand for an exchange-traded note tied to equity volatility that Credit Suisse Group AG last month stopped issuing shares in the VelocityShares Daily 2x VIX Short-Term ETN. (TVIX) The TVIX, as the product is known, saw its market value more than quadruple before the halt.
The European Central Bank last week said it will lend 800 financial institutions a record 529.5 billion euros ($705 billion) for 1,092 days to relieve strains and ease the flow of credit to households and businesses across the 17-member currency region.
ECB President Mario Draghi on March 1 said he’s “reasonably satisfied” with the provision. Euro-area finance ministers that day authorized the region’s bailout fund to raise money for Greece’s bond exchange, the first step in releasing funds from a 130 billion-euro rescue package.
“There’s the European background of risk out there that doesn’t play directly in the U.S. markets, but definitely plays in the fear of the downside,” Salvino, a specialist on the CBOE floor for Group One Trading, the primary market maker for VIX options, said in a March 1 phone interview. “We’re kind of climbing the wall of worry.”
The S&P 500 rose to 1,374.09 on March 1, its highest level since 2008. Employers probably added more than 200,000 workers for a third straight month in February amid optimism about the U.S. expansion, economists said before a report this week.
Payrolls increased by 210,000 last month after rising 243,000 in January, the most in nine months, and 203,000 at the end of 2011, according to the median projection of 55 economists surveyed by Bloomberg News. It would mark the strongest three- month stretch in almost a year. The jobless rate probably held at an almost three-year low of 8.3 percent.
“I feel pretty good about where the pieces of the puzzle are at this point,” Scott Billeadeau, who helps oversee about $14.5 billion at Fifth Third Asset Management in Minneapolis, said in a March 2 telephone interview. “Greece is kind of put away. Things in the economy are definitely better.” The U.S. stocks rally “could have some legs left to it,” he said.
Swings in the level of the VIX during the past 30 days haven’t been this high since July 2007 versus the volatility of the S&P 500. Realized volatility for the VIX was 80.37 in the last 30 days, 9.8 times the measure for the equity gauge, data compiled by Bloomberg show. The ratio peaked at 10.4 on Feb. 27.
“The market is having trouble pricing risk,” BMO’s Breier, a senior equity derivatives trader in New York, said in a Feb. 29 phone interview. “You have a unique situation with low volatility in the equity market and we’ve got an overhang, which everyone acknowledges has the potential to unravel the market. So which one do you give greater weight to?”
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