Global Stock Volatility Surges as Traders Seek Hedges on Japan
Options prices and bets on higher equity volatility jumped from Tokyo to Frankfurt and Chicago as investors sought protection against stock-market losses amid concern that the risk from radiation leakage at a power plant in Japan is increasing.
The Chicago Board Options Exchange Volatility Index, or VIX, climbed 15 percent to 24.32 as of 4:15 p.m. in New York, the highest close Aug. 31. The VStoxx Index (V2X), which measures options on the Euro Stoxx 50 Index, rose 16 percent to a three-month high of 31.01. Swap contracts that gain with higher volatility rose the most since May, according to data compiled by Bloomberg and Deutsche Bank AG.
Demand for protection surged after falling to the lowest level in more than three years in December, when the global rally in stocks was approaching a two-year anniversary. The Standard & Poor’s 500 Index has gained 90 percent since March 9, 2009, as central banks around the world kept interest rates at record lows and companies beat earnings estimates.
“Welcome back to equity risk,” said John Farrall, who helps oversee $106 billion as director of derivatives strategy at PNC Wealth Management in Cleveland. “A lot of the better strategists were frustrated that they were selling umbrellas in summer a few weeks ago when no one wanted protection.”
Stocks sank today, with the Nikkei 225 index posting its biggest two-day drop since 1987, after Japan’s Prime Minister Naoto Kan said the danger of further radiation leaks increased at a Tokyo Electric Power Co. located 135 miles (217 kilometers) north of Tokyo. The MSCI All-Country World Index of shares in 45 nations tumbled 2.2 percent to 326.83, and the S&P 500 retreated 1 percent after losing as much as 2.7 percent.
Equities rebounded when Asian markets opened for March 16 trading, pushing the MSCI Asia Pacific Index to its first advance in five days. The HSI Volatility Index, the benchmark gauge for Hong Kong stock options, tumbled 9.2 percent to 25.26 as of 2:43 p.m. local time, the biggest drop since Feb. 25.
The Bank of Japan’s actions to provide short-term liquidity and expand an asset-purchase program failed to contain investor panic following a 9-magnitude earthquake that was the nation’s strongest on record. The March 11 quake and ensuing tsunami sent more than 300,000 people to emergency shelters and may have killed 10,000 in Miyagi prefecture north of Tokyo, according to company statements and police estimates.
“The situation in Japan is progressively getting worse,” said Markus Huber, head of German sales trading at ETX Capital in London. “Historically, when there is a sudden increase in volatility, it takes a fair amount of time until markets return to ‘normal’ again. Measures of volatility still have loads of room to the upside.”
The Nikkei Stock Average Volatility Index, a measure of Japanese option prices, has surged 229 percent to a two-year high of 69.88 in the past three days. The gauge closed at this year’s low of 16.12 on Feb. 8 and implies a 20 percent swing in the Nikkei 225 Stock Average in the next 30 days.
“Nikkei volatility exploded because the uncertainty is so high,” said Philippe Trouve, the VIX options trader and director for equity derivatives at Bank of America Corp. in New York. “If things really get worse in Japan, then we could see VIX and other volatility measures go higher.”
The earthquake is becoming the biggest threat to investors’ risk appetite following violence in Libya, slowing Chinese exports and concern some European nations may have to restructure their debt.
“There was reasonably aggressive buying of volatility, while previous to this with the recent crisis in the Middle East and North Africa, we hadn’t seen such a strong reaction,” said Bhavin Patel, equity derivatives strategist at Royal Bank of Scotland Group Plc in London.
The VIX, as the CBOE Volatility Index is known, traded at 21.98 on average in the year through March 11. VIX call options, used to bet that the index will rise, represented more than two- thirds of the total volume of options traded today.
April VIX futures rose 4.9 percent to 23.40, the lowest reading among all contracts on the index. June futures increased 2.6 percent to 24.15. The VIX has averaged 20.37 over its two- decade history.
“The back months are all up almost 3 percent, which is a pretty serious move, but it makes sense given what we’re seeing here,” said Dominic Salvino, a specialist at Group One Trading, the primary market maker for VIX options. “Higher oil alone had the back months coming off their lows and Japan isn’t helping. We don’t expect them to come in any time soon.”
Crude oil futures jumped 28 percent to $106.95 a barrel in New York between its intraday low on Feb. 15 and the peak on March 7, driving the S&P 500 down 1.4 percent.
Calls give holders the right to buy an underlying security at a given price and by a set date. Puts give the right to sell.
At Least May
Instruments to speculate on volatility in the Euro Stoxx 50 known as variance swaps that expire in June 2011 were indicated at 30.5 percent, from 27.5 percent yesterday, according to Deutsche Bank in London. The contracts were poised for the biggest daily increase for similar-maturity products since at least May, said Pam Finelli, equity derivatives strategist for the Frankfurt-based bank.
December variance swaps on the Nikkei today climbed to 37 percent, from 22 percent before the quake struck, according to RBS. A variance swap is a privately traded contract that allows traders to bet on the volatility, or magnitude of price swings, in an underlying security.
Finelli at Deutsche Bank said today’s reaction follows historically low levels for measures such as the VIX.
“We are certainly seeing de-risking, but I wouldn’t say there is necessarily panic in derivatives flows,” she said in an interview. “A lot of the flows we’ve seen have been a bit of a two-way stream. We are seeing people rolling out protection to longer maturities, but we are also seeing profit-taking on existing hedges.”
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