Option players seek shelter as risk gauge rises

Thu May 17, 2012 6:57pm EDT

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(Reuters) - Option investors are seeking protection against a sharp decline in U.S. equities in the near term as uncertainty grows over the European debt crisis and the health of the global economy.

Wall Street stock indexes hit a four-month low on Thursday as rising Spanish bond yields increased investor anxiety over that country's banks and another round of weak U.S. data undermined hopes for the economic recovery.

The benchmark S&P 500 index, which logged its fifth straight session of declines, has fallen 6.1 percent so far in May.

A key measure of financial market swings - or volatility - has been steadily rising from the 15 to 16 level at the start of May. Projected volatility on the Standard & Poor's 500 Index, as measured on the CBOE Volatility Index, or VIX, jumped 9.97 percent to 24.49 - its highest since December 19, 2011.

"The volatility that we have seen in the market over the past few weeks has triggered another rise in risk perceptions, similar to what we saw in August and October last year," said WhatsTrading.com options strategist Frederic Ruffy.

Trading was brisk in the U.S. options market on Thursday with an underlying bearish tone heading into Friday's expiration of May options, which may have contributed to the volume.

"You are seeing a lot of puts being bought on the major stock market indexes today suggesting that there is a lot of fear and uncertainty surrounding this market," said Joe Bell, senior equity analyst at Schaeffer's Investment Research.

"Often times this indicates that investors are increasing their hedges against a continued decline in the market. Ever since the U.S. earnings season has slowed down, the focus has been on the European debt crisis," he added.

Although a VIX in the 20s is a far cry from the 2011 high of 48 and a peak of 89.53 after the collapse of Lehman Brothers in 2008, the index this week has been above its historical average of 20.50 and has soared 47.5 percent since the May 1 close.

The VIX closed at 21.97 on Tuesday, above its average of the past six months for the first time in more than 100 days, which is a long period for volatility to be below average, Jason Goepfert, president of SentimenTrader.com, said in a report this week.

"That's the sixth time it's had such a streak in the past decade and the eighth since 1986," Goepfert said.

The VIX has risen in 10 out of the last 12 trading sessions.

"That means that the concerns about Europe may not go away and that uncertainty is growing," said Bill Luby, a private investor and author of the VIX and More blog in San Francisco.

MKM Partners derivatives strategist Jim Strugger recommends the purchase of June calls on the VIX as a hedge on the potential for higher levels of implied volatility and a sharp decline in U.S. stocks in the near term.

"Historically, volatility shocks have occurred with VIX spiking from its staging area in the 20-25 range," Strugger said. Calls on the VIX are often used as a hedge against greater volatility.

About 14.7 million puts and 10.5 million calls traded across all the U.S. option exchanges, yielding a put-to-call ratio of 1.40, its highest since August 8, 2011, according to option analytics firm Trade Alert. The put/call ratio for trading in all products across all exchanges has now exceeded 1.0 for three consecutive trading sessions, which is the first time since November 8-10, 2011, WhatsTrading's Ruffy said.

Option volume was impressive in the SPDR S&P 500 Trust, an ETF more popularly known as the Spyders and the S&P 500 Index.

In the SPX, 1.27 million puts traded, its highest level since August 2011, against 510,000 calls. And in the Spyders, a total of 4.85 million contracts changed hands with 2.59 puts traded for every call, Trade Alert data showed.

(Reporting by Doris Frankel, Editing by Gary Crosse)

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