Options fear gauge rises on financial woes

CHICAGO (Reuters) - The Chicago Board Options Exchange Volatility Index, Wall Street's favorite measure of investor fear, on Monday topped a 30 reading for the first time in six months as investors sought protective options on worries about the stability of the U.S. financial system.

A late wave of selling in U.S. stock benchmarks sent the VIX up 6.04 points, or 23.54 percent to 31.70, its highest level since March 17, when JPMorgan Chase & Co announced plans to acquire Bear Stearns Cos, which was weakened by massive exposure to mortgage markets.

The surge in the VIX was the biggest one-day point gain since February 27, 2007, when U.S. stocks tumbled following a sell-off in Chinese stocks.

"Today's rise in the VIX reflects concerns about the U.S. economy and additional fallout in the financial sector," said Scott Fullman, director of derivatives investment strategy at broker-dealer WJB Capital Group.

U.S. stocks sank after Lehman Brothers Holdings Inc sought bankruptcy protection, insurer American International Group struggled for survival, and Merrill Lynch agreed to be bought by Bank of America.

The benchmark Standard & Poor's 500 index fell 4.71 percent to 1,192.70, posting its biggest percentage drop since the day that markets reopened after the September 11, 2001, attacks.

The VIX, which tracks projected stock market volatility embedded in near-term S&P 500 option prices, typically runs inversely to the S&P index and rises sharply when investors are inclined to bid up options to manage stock market risk.

The S&P 500 dropped to its lowest close since October 2005 and breached a key technical support level as it fell.

The sell-off was accompanied by "a flurry of put buying as investors were left scrambling for portfolio protection once again," said Frederic Ruffy, options strategist at web site WhatsTrading.com.

About 683,000 S&P 500 puts traded on the day, more than double the number of call options, according to option analytics firm Trade Alert. "Heavy buying of SPX puts explains the surge in the VIX," Ruffy said.

"It may be that some investors feel that we know more now that we did last Friday but other people feel there are still more questions to be resolved in the financial area," said Thomas Haugh, chief investment officer with PTI Securities, an options and futures brokerage firm.

(Editing by Leslie Adler)