* Low volumes show investors sitting out market move
* Short-term players buying risk assets on dips
* Interest in one-month downside protection picks up
By Toni Vorobyova and Nia Williams
LONDON, March 18 (Reuters) - European investors said a surprise bank tax in Cyprus was not a reason for a sustained market drop and some saw Monday’s weakness as an opportunity to buy stocks and the euro.
The weekend announcement that Cyprus would tax bank deposits as part of a 10 billion euro ($13 billion) bailout by the European Union broke with previous practice that depositors’ savings were ring fenced.
The euro, euro zone equities and Italian and Spanish sovereign bonds initially fell in reaction to the news but all recovered some of the losses by mid-session.
Equity volumes were quite subdued given the size of the move in risk assets, suggesting that longer-term players did not join the sell-off, holding on to stocks that offer much higher dividends than U.S. peers and are cheaper relative to earnings.
Euro zone banks were the worst hit, but investors thought that weakness could prove short-lived.
“It’s affecting my portfolio this morning because I am a bit overweight financials. I am not doing anything about it. My initial thoughts are that this is a circumstance that is peculiar to Cyprus,” said Kevin Lilley, European equities fund manager at Old Mutual Asset Management.
“I don’t have any cash in my portfolio but, if I did, I probably would have used it as a buying opportunity.”
He added that the worst case scenario for European stocks - and the one that would prompt him to reconsider his holdings - would be if Cyprus parliament rejects the bailout when it votes on Tuesday.
Neil Dwane, chief investment officer for Europe at Allianz, Didier Duret, global chief investment officer at ABN-AMRO Private Banking, Nicola Marinelli, fund manager at Glendevon King, and Lorne Baring, managing director at B Capital, all said they were sticking to their current investments in Europe.
“Selling positions or taking protection now is trying to close the door after a horse has bolted,” said Baring, whose holdings include a long bet on the German DAX index.
“In the end, probably Europe and global markets will ride through this okay.”
Stocks have rallied and bonds fallen since the European Central Bank said last summer it was committed to the euro and would buy bonds of troubled members if needed. Investors said this promise provided reassurance through near-term volatility.
“After the initial euro decline, we expect a rebound,” analysts at Morgan Stanley said in a note. “We do not think that it is the time to position for the longer-term euro weakness we expect, as the periphery still offers relatively high yields and risk is mitigated by the OMT (ECB’s bond buying) backstop.”
Those who did want to prepare for a possible continuation of the sell off were using derivatives.
Implied volatility on the euro and euro zone blue chips - which is based on options prices and rises at times of investor demand for protection - jumped. So did appetite for near-term put options, which give investors the right to sell stocks or the currency at a pre-set price.
Ion-Marc Valahu, who runs Geneva hedge fund Clairinvest, was among those who bought implied volatility on EuroSTOXX 50, adding to already held positions on expectations of “at least a 5 percent sell off soon” in equities.
However, the biggest moves were on the one-month horizon, with longer-dated volatility more subdued, signalling that any market weakness is expected to be fairly short-lived.
“There’s some stress here with the short-dated vols going higher. People are a lot more worried about the downside,” said Olivier Korber, options strategist at Societe Generale.
If the Cyprus situation did get worse, the euro - which has had a very strong start to the year - may suffer.
“Contagion on the bond side to some of the other peripheral markets will be short-lived but the euro as a currency will definitely be the one that bears the brunt if there is an increase in risk aversion and uncertainty about the European project,” said Dagmar Dvorak, director of fixed income and currencies at Baring Asset Management, sticking by her underweight position on the European currency.