UPDATE 1-Volatility index soars as US investors seek safety

Thu Feb 4, 2010 5:43pm EST

* S&P 500 historical volatility rising

* VIX futures trade in 25 range for 2010

* Traders seek ETF put options as likely protection (Recasts lead, Adds details on ETF option volume in paragraph l3)

By Doris Frankel

CHICAGO, Feb 4 (Reuters) - Volatility has vaulted out of its slumber.

The worst sell-off in U.S. stocks in more than nine months on Thursday sent Wall Street's favorite measure of investor anxiety, the Chicago Board Options Exchange Volatility Index .VIX, sharply higher as investors scrambled to buy portfolio protection.

The index, known as the VIX, jumped nearly 21 percent to 26.08 as U.S. stocks sank amid persistent fears over European sovereign debt problems and an unexpected increase in U.S. jobless claims a day ahead of crucial payrolls data.

"Investors are clamoring for protection," said Ryan Renicker, equity derivatives strategist at broker-dealer Ticonderoga Securities.

"The risks associated with sovereign debt and the uncertainty coming into Friday's jobs report have prompted investors to hedge their stock positions by buying put options on the S&P 500 and VIX call options."

Since topping out at a 28 reading on Jan. 22, the VIX had been trending lower over the past two weeks. But it reversed course violently on Thursday, indicating expectations for future daily moves of 1.5 percent in the S&P 500.

The VIX is a 30-day risk forecast priced off of Standard & Poor's index .SPX option prices and often moves higher when the S&P benchmark falls sharply as investors bid up options to manage their stock market risk.

Investors are concerned that stocks will keep falling in the near term. "Even in the exchange-traded funds that track major stock benchmarks and sectors, investors are aggressively buying insurance," said optionMonster analyst Chris McKhann.

Another big driver is the actual volatility in the market, which has been rising. S&P 500 historical volatility over the past 22 trading days stood at 18.71 percent up from 16.5 percent the previous day, Renicker said.

Over the last 16 trading days, the S&P 500 has moved more than 1 percent on 10 of those days, according to Bespoke Investment Group, an investment firm in Harrison, New York.

VIX futures are trading in the 25 range, also suggesting that traders are looking for wider stock market swings at least for the next six months, McKhann said.

BUSY ACTION IN ETF PUTS

Many traders expecting downside movement turned to exchange-traded funds tracking the major benchmarks and sectors to hedge risk.

In the ETFs, about 3.40 million puts and 2.19 million calls traded, or 130 percent the recent average daily turnover. By contrast 609,000 puts and 559,000 calls changed hands across all the cash indexes, which represents approximate typical levels, according to option analytics firm Trade Alert.

The action shows that increasing numbers of investors are turning to ETF puts rather than index puts when hedging bets on volatility days, said WhatsTrading.com options strategist Fred Ruffy.

Volume leaders were the SPDR S&P 500 ETF Trust (SPY.P), Powershares QQQ Trust Series 1 fund QQQQ.O, the iShares Russell 2000 Index (IWM.P), the iShares MSCI Emerging Markets Index (EEM.P). and the Select Sector SPDR Financial fund (XLF.P).

Put-to-call ratios in the QQQQs, IWM, XLF and EEM are twice their recent average, said McKhann.

Some traders have already employed their hedging and risk strategies. Options bets initiated last month in several ETFS suggested traders were positioning for a substantial pullback in the consumer, basic materials, banks and retail sectors by March expiration. For details, please see [nN22145195]. (Editing by Diane Craft and Leslie Adler)

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