Wary of the rally in European stocks, traders look for protection

Thu May 15, 2014 8:16am EDT

* DAX briefly hits record high

* Traders wary of any Q2 sell-off after rally

* Fund managers change bets for protection

By Sudip Kar-Gupta

LONDON, May 15 (Reuters) - Traders are scurrying to protect themselves against any second-quarter retreat by European equity markets, with many investors looking for signs to sell out of a rally that has driven indexes to multi-year highs.

Expectations that the European Central Bank will introduce measures in June to stimulate the euro zone economy have also boosted equities. Germany's DAX index hit a record high 9,810 points on Thursday. The euro zone's Euro STOXX 50 index is near its highest in around 6 years.

But some traders are positioning themselves in case any boost the ECB gives European stocks proves short-lived and leads to a sell-off later. They are especially concerned because second quarters are often muted for stock markets.

"I think this will be a 'sell in May and go away' year," said SteppenWolf Capital Chief Investment Officer Phoebus Theologites. "This EU-phoria cannot last forever. Nothing is fixed in the euro zone."

Dealers added that options were at relatively cheap prices at present. The price of options is typically linked to the implied volatility of an index and implied volatility on the DAX has fallen over the last month.

Signs of lingering problems in the euro zone emerged on Thursday. Germany reported strong growth in the first quarter of this year, but the French economy came to a standstill and Italy's contracted.

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European economic overview: link.reuters.com/zuh26v

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Theologites said he had taken out a "put" option on the DAX, giving the right to sell that index at 9,500 points in September - essentially a bet the DAX would fall some 3 percent by then.

He said while any interest rate cut by the ECB in June could help German exporters, which in turn could theoretically boost the DAX, it could also impact the purchasing power of consumers in Spain and Italy - which are also key markets for Germany.

"The effect of a rate cut on the DAX may not be as clear-cut as many think."

Clairinvest fund manager Ion-Marc Valahu also said he had sold out of "call" options betting on gains on the DAX, Spain's IBEX equity index and Italy's FTSE MIB index.

"I think we are opening ourselves for disappointment from the ECB," he said. (Reporting by Sudip Kar-Gupta; Editing by Lionel Laurent, Larry King)

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