Concern that stocks will plunge has never been higher in global options markets, and that may mean it's time to buy.
Concern that stocks will plunge has never been higher in global options markets, and that may mean it's time to buy.
Futures on the Chicago Board Options Exchange Volatility Index are pricing in a three-month gain of 31 percent and contracts based on swings in Europe and emerging-market equities have risen to near records, data compiled by Bloomberg show. Five of the seven times the VIX gap widened this much, the Standard & Poor's 500 Index rose 11 percent on average in the next six months. One exception was May 2008, two months after Bear Stearns Cos. collapsed and before a 40 percent drop.
Investors are trying to decide if record pessimism is warranted amid signs $1 trillion of emergency spending in Europe is failing to cure the region's debt crisis, while American companies aren't hiring. Bulls say the best time to purchase stocks is when fear is rising and that forecasts for the biggest surge in corporate profits in two decades mean equities will prove to be a bargain even as the global economy slows.
“We had too much negativity, and it will take time for confidence to come back,” said Matthias Fankhauser, a Zurich- based fund manager at Clariden Leu, which oversees $100 billion. “Whatever you look at, equities are very attractive now. The market is overshooting, and if you get a slight change in sentiment, you could get a nice upside from here.”
Newmont Mining Corp. and Reynolds American Inc. are among companies whose premium for three-month options has risen to the highest level in a year, data compiled by Bloomberg show.
Weekly Advance
The S&P 500 climbed 1.2 percent to 1,122.34 as of 10:30 a.m. in New York after Chinese industrial production rose the most in three months. The stock benchmark gained 0.5 percent to 1,109.55 last week, pushed up after first-time claims for unemployment benefits declined. The CBOE gauge climbed 3.2 percent to 21.99, posting the first weekly advance since Aug. 13. Three-month futures on the VIX closed 8.09 points higher than the measure on Sept. 3, holding near a record set July 20.
December futures on Europe's VStoxx Index are 5.1 points higher than the gauge, near the most since the derivatives were introduced by Deutsche Boerse AG's Eurex in June 2009. Three- month options on the iShares MSCI Emerging Markets Index, an exchange-traded fund tracking stocks in 21 developing nations, cost 30 percent more than this month's contracts, the most since November 2006.
VIX Futures
The price of VIX futures expiring in three months has exceeded the level of the index by 5 points or more seven times since 2004, according to data compiled by Bloomberg. Five times, the S&P 500 rallied during the next six months, including the 27 percent surge that began in July 2009. The benchmark measure of U.S. stocks increased 6.6 percent starting in June 2004.
Expectations for higher volatility suggest too much pessimism, meaning stocks are worth buying, according to Pierre Lapointe, global macro strategist at Brockhouse & Cooper Inc. in Montreal. His firm oversees $500 million and advises more than 200 asset managers worldwide.
“Negativity in the market is very, very high,” Lapointe said. “We're still bullish and think the recent soft patch is normal in an economic recovery pattern. We would not be buyers of volatility.”
The S&P 500 has slipped 2.1 percent to 1,104.18 since the Federal Reserve said Aug. 10 that the pace of economic recovery is likely to be “more modest” than previously forecast. September is the worst month for U.S. stocks, with the S&P 500 falling 1.2 percent on average since 1928. The second-biggest average monthly slump is February at 0.3 percent.
Portfolio Protection
Investors are snapping up Treasuries amid concern the U.S. is headed for the second recession in three years, driving yields on 10-year notes down to 2.4158 percent on Aug. 25. The payout was last that low in April 2009, during the aftermath of the worst financial crisis since the Great Depression.
“If the bond market is right and you have a slowdown in the economy, then stock markets should also come down,” said Gilbert Keskin, Paris-based manager of Amundi's Volatility funds, which have 5 billion euros ($6.4 billion) in assets. “That is why investors are protecting their portfolio by buying options or futures on the VIX.”
The recovery in the U.S. weakened in the second quarter more than the government previously estimated. The world's largest economy grew at a 1.6 percent annual pace, down from a projection of 2.4 percent in July, the Commerce Department said Aug. 27. Economists estimated a 1.4 percent expansion, the median of 81 forecasts in a Bloomberg survey.
‘Thin Rope'
While companies in the U.S. added 67,000 jobs in August, beating the median economist estimate of 40,000, monthly private employment growth has slowed from a peak of 241,000 in April. In Europe, the sovereign-debt crisis that threatened to tip the region back into recession shows no signs of ending. The yield premiums investors demand to hold Greek, Spanish and Irish debt rather than German bunds are even wider than before the EU announced its rescue package for the region on May 10.
“It's a thin rope we are walking, certainly in the developed world, so you can fall on one side or the other,” said Patrick Moonen, a senior strategist at ING Investment Management in The Hague. The firm oversees $462 billion. “Volatility will remain high just because of the high uncertainty on the macro outcome.”
May Crash
Investors may still be shaken by the May 6 crash that erased $862 billion from U.S. equities in less than 20 minutes. The VIX, which measures the cost of options that protect against losses in the S&P 500, soared the most in 19 months that day to 32.80.
“Market participants are taking a once bitten, twice shy attitude,” said Bhavin Patel, London-based derivatives strategist at Royal Bank of Scotland Group Plc. “The experience of sharp recent moves, coupled with a fragile economic scenario, has helped put up this premium on volatility.”
Newmont Mining's three-month option prices rose this month to 1.1 times one-month contracts, the highest ratio since January 2007 for the Greenwood Village, Colorado-based company. The largest U.S. gold producer has rallied 28 percent since Dec. 31 as futures on the metal rose 14 percent this year and reached a record $1,266.50 an ounce on June 21.
The ratio for Winston-Salem, North Carolina-based Reynolds American options is 1.24, just under last month's 15-month high of 1.25. The second-largest U.S. tobacco company has gained 7.7 percent this year.
Profit Growh
Bulls are counting on projections of 36 percent and 15 percent earnings growth for S&P 500 companies in 2010 and 2011, respectively, according to the average analyst forecasts in a Bloomberg survey. Sentiment on stocks is already turning around. Individuals' confidence in U.S. equities has soared in the biggest two-week climb since March 2009, according to the American Association of Individual Investors.
“It's a tug of war between the bleak economic data we are getting and the positive comments from companies,” said Cyril Castelli, a London-based strategist at Louis Capital Markets LP, which advises hedge funds. “Money is to be made betting against those projected high levels of volatility.”
