Earnings Eclipsed as Correlations Hit Record on Europe: Options

Speculation Europe’s economy will contract is drowning out better-than-expected corporate results and pushing correlations among stock prices to the highest level of any earnings period, according to equity derivatives trading.

The Chicago Board Options Exchange S&P 500 Implied Correlation Index posted its biggest gain in two years of data this week, sending its closing average since Oct. 11 to 78.21, according to data compiled by Bloomberg. That’s the highest level for the first 16 days of a reporting season, data show.

Traders are betting U.S. equities will move in unison as investors react to news about Europe’s attempts to end its debt crisis. More than 400 stocks in the S&P 500 moved in the same direction in three of the last four days. Investors first snapped up shares when Europe’s leaders agreed to expand the region’s bailout fund and then fled equities when Greece said it would hold a referendum on the plan.

“It’s been brutal,” Philip Orlando, who helps oversee about $350 billion as chief equity market strategist at Federated Investors Inc. in New York, said in a phone interview yesterday. “October was easy. It’s a little more difficult now given this knee-jerk reaction to the stunning Greek development over the last 24 hours. A lot of folks like us are trying to get our hands around this and figure out what it means.”

The last time equities moved together to such a degree was in October 1987, when the index plunged a record 20 percent on Oct. 19, according to data compiled by New York-based JPMorgan Chase & Co. The Credit Suisse Fear Barometer, a gauge of prices to sell three-month S&P 500 calls while buying puts, soared 40 percent from Oct. 3 to Oct. 27 for the biggest gain during that period since November 2008.

Rising, Falling

As the equity market surged in October, 477 out of 500 companies in the S&P 500 rallied. Yesterday, 479 dropped, while 447 rose today.

The CBOE Volatility Index, or VIX, decreased 30 percent last month as the S&P 500 rallied 11 percent for the biggest monthly gain since 1991. The volatility gauge has surged 42 percent over the past two days to 34.77 as concern grew the European debt crisis may spread. The VStoxx Index (V2X), which measures the cost of Euro Stoxx 50 Index options, soared 22 percent to 42.96 yesterday, posting its biggest two-day increase since May 2010. The VIX fell 5.8 percent to 32.74 today as the VStoxx decreased 1.9 percent to 42.14.

Hedge-Fund Managers

“Even macro hedge fund managers are having a hard time, and these are supposed to be markets that they like,” Liam Dalton, chief executive officer of Axiom Capital Management Inc. in New York, which oversees $1.8 billion, said in a telephone interview yesterday. “The news flow is playing such a big part of the price movement that unless you can predict news flow, it’s difficult.”

U.S. stocks rallied in October after European Union leaders agreed to expand their rescue fund’s capacity to 1 trillion euros ($1.4 trillion) and persuaded bondholders to take 50 percent losses on Greek debt. The U.S. economy grew in the third quarter at a 2.5 percent rate, the fastest pace in a year, the Commerce Department said on Oct. 27.

The S&P 500 lost 2.8 percent today and 2.5 percent yesterday, the biggest two-day retreat in a month, amid concern the bailout will unravel. Greek Prime Minister George Papandreou’s grip on power weakened after his call for a referendum on the rescue provoked lawmaker defections from his party and fueled concern a default would undermine financial stability in the region.

Greek Debt

Greece’s debt was 145 percent of GDP last year, higher than any other nation in the region, according to the European Commission.

“It’s very difficult to have an orderly unwinding of excess debt on this level, it’s just not going to be orderly,” Hayes Miller, who helps oversee $51.6 billion as the Boston- based head of asset allocation in North America at Baring Asset Management Inc., said in a telephone interview.

Over the last three weeks, American companies have reported profits that are beating Wall Street estimates by an average of 5.9 percent. Among 334 companies that have reported results, 248 have exceeded forecasts, data compiled by Bloomberg show.

“I’m not pessimistic about European equities from a fundamental perspective, it’s just that the politics have such a big influence right now,” Alex Tedder, who helps manage $13.5 billion in global stocks at American Century Investments in New York, said in a telephone interview yesterday.

Implied Volatility

Implied volatility, the key gauge of options prices, for S&P 500 contracts expiring in three months surged 27 percent from Oct. 28 to 27.71 yesterday. The price of the index’s options 10 percent below the current level was 12.37 points higher than that of contracts 10 percent below it, the widest spread since June 2010.

S&P 500 December 1,050 puts and December 1,100 puts were the most-traded options for the index yesterday, Bloomberg data show. The 9.5 million total puts outnumber calls by a ratio of 1.61-to-1.

“When you see the VIX and correlation rip the way they have, it tells us that people are focused back on macro events, particularly Europe, which is still in the cross hairs,” Nelson Saiers, who helps oversee about $635 million as chief investment officer of the New York-based volatility hedge fund Alphabet Management LLC, said in a phone interview yesterday. “It’s all the more notable given that we’re at the height of earnings.”

To contact the reporters on this story: Jeff Kearns in New York at jkearns3@bloomberg.net; Cecile Vannucci in Amsterdam at cvannucci1@bloomberg.net

To contact the editors responsible for this story: Nick Baker at nbaker7@bloomberg.net; Andrew Rummer at arummer@bloomberg.net

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