Options traders have increased bearish bets on the DAX Index to a more than five-year high versus the rest of Europe, seeking to protect gains after the German equity gauge rallied 17 percent in the first quarter.
Puts outnumbered calls by 1.41-to-1 for the DAX yesterday, according to data compiled by Bloomberg. The ratio exceeded the put-to-call measure for the Euro Stoxx 50 Index by 24 percent on March 29, the most since December 2006.
Investors are buying protection on the DAX, which posted the biggest first-quarter advance among European developed markets, amid concern that attempts to contain the debt crisis are unraveling as yields on Spanish and Italian government debt rise. Spain is in “extreme difficulty,” Prime Minister Mariano Rajoy said last week as he raised the possibility of needing Europe’s fourth national bailout. Germany is Europe’s biggest provider of rescue funds.
“There’s been a tendency to overweight the DAX this year,” Henrik Drusebjerg, who helps oversee $230 billion as senior equity strategist at Nordea Bank AB in Copenhagen, said in a phone interview yesterday. “If you don’t believe that we are on the brink of a new dramatic downfall in equities, it makes sense to protect the returns you got already this year on the DAX. Puts may be an interesting proposition.”
The DAXK Index, a version of the DAX that excludes gains from dividends, jumped 17 percent in the first three months of the year, posting its best first quarter since 1998. It has dropped 7.1 percent since its seven-month high on March 16 on renewed concern about the European debt crisis. The gauge rebounded 1 percent yesterday as European Central Bank Executive Board member Benoit Coeure triggered speculation that the bank will revive its bond-purchase program to lower Spain’s borrowing costs.
Spain’s Bond Yields
Before Coeure’s remarks, Spanish 10-year bond yields touched 6 percent yesterday for the first time in 2012, fueling concern the nation would follow Greece, Ireland and Portugal in seeking a European bailout. The government is trying to implement the deepest austerity steps in at least three decades even as the economy suffers its second recession since 2009.
“The market has its doubts about the DAX’s recent outperformance,” Lara Koch, founder of Macrocatalysts, a research firm in New York, said in a phone interview yesterday. “There is an underlying sensitivity to the European issue, as we witnessed this past week. I don’t think the debt crisis ever stopped deteriorating. It was all buying time.”
The German economy appears to be overcoming a “phase of weakness,” the Economy Ministry said in an e-mailed preview of its monthly report on April 10.
Ownership of bearish DAX options rose 18 percent since March 19 to 2.94 million on April 11, while call open interest gained 9.6 percent to 2.08 million, according to data compiled by Bloomberg. Traders pushed the cost of protecting the DAX higher. Implied volatility, the key gauge of options prices, for one-month contracts closest to the index level climbed to 27.76 on April 10, the highest relative to two-month options since December, according to data compiled by Bloomberg.
“If investors have a particularly bearish view, and they think they are going to experience higher volatility and they want to hedge their positions, then buying one/two-month volatility could be a possibility now,” Eugenio Montersino, a London-based volatility analyst at Lombard Street Research Ltd., said in a phone interview yesterday.
Unemployment at a two-decade low, accelerating wages and falling borrowing costs are spurring consumers in Europe’s linchpin economy to spend more. The nation’s economy will expand 0.7 percent this year, while gross domestic product in the euro area will shrink 0.4 percent, according to the median economist estimates in Bloomberg surveys.
‘Very Undemanding Valuations’
“The fundamentals of the economy are clearly very strong, but more importantly we find there are a lot of companies that are world-class exporters on very undemanding valuations,” James Buckley, who helps oversee $50 billion at Baring Asset Management Ltd. in London, said in a phone interview yesterday. “It is a market where we continue to find opportunities.”
DAX companies are valued at 10.37 times profit for the next year, according to data compiled by Bloomberg. That’s 13 percent below the average projected price-to-earnings ratio of 11.92 for the past five years.
Investors may also want to hold on to German shares from Bayer AG (BAYN) to BASF SE (BAS) and Munich Re that give a right to dividends in the next month, according to Andreas Bernhard, a sales trader at Donner & Reuschel in Munich. Almost 85 percent of dividend points in the DAX for the year starting April 2012 will be granted this month and in May, Bloomberg estimates show.
The VDAX Index, a measure of options prices on the DAX, lost 2.6 percent to 24.11 yesterday. The VStoxx Index (V2X), which measures the cost of Euro Stoxx 50 Index options, slid 3.9 percent to 29.49. In the U.S., the Chicago Board Options Exchange Volatility Index, known as the VIX, declined 1.8 percent to 20.02.
Since March 19, nine of the 10 DAX options with the biggest increases in ownership were bearish, according to data compiled by Bloomberg. May 6,000 puts (DAX), 10 percent below yesterday’s close, added the most, rising to 20,424 contracts from 1,716. December 6,000 puts had the biggest open interest among all DAX contracts, the data show.
“The main reason why people are choosing to protect the DAX first is because of the relatively better performance of that index to the Euro Stoxx 50,” Donner & Reuschel’s Bernhard said in a telephone interview yesterday. “People thought the downwards potential is higher in the DAX.”
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