Traders are protecting against losses after the biggest rally for stocks this decade, pushing the VIX to a record-long streak of gains as the Federal Reserve considers reducing economic stimulus.
The Chicago Board Options Exchange Volatility Index has risen for 14 of the past 16 trading days, the first time that has ever happened, data compiled by Bloomberg show. Investors bought almost 1.3 million VIX call options since Nov. 25, compared with about 139,000 puts. The index is used as an equity hedge since it moves in the opposite direction of the Standard & Poor’s 500 Index about 80 percent of the time.
The Fed has quadrupled the central bank’s assets since 2008 with bond purchases to reduce borrowing costs and boost economic growth, helping send the S&P 500 up 25 percent this year, the biggest increase since 2003. About 34 percent of economists surveyed by Bloomberg on Dec. 6 predicted the Fed will start to reduce the stimulus when it concludes a policy meeting today.
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“This is insurance against a Fed surprise,” Randall Warren, chief investment officer of Warren Financial Service in Exton, Pennsylvania, said yesterday in a phone interview. His firm manages more than $100 million including options. “It seems like although everything you read in publications is about institutional investors being bullish into 2014, here they are buying crash protection.”
Investors have poured $126 billion into U.S. equity exchange-traded funds this year, compared with $65 billion in 2012, data compiled by Bloomberg show. Gains have pushed the S&P 500 to a record 1,808.37 this year, more than 15 percent above the high set in October 2007.
The Fed has said it will keep buying bonds until the outlook for the labor market has “improved substantially.” Nine of the 35 economists surveyed said the central bank will buy fewer bonds at its January meeting, and the remaining 14 predict tapering will start in March.
The VIX, calculated using S&P 500 options expiring over the next 30 days, has jumped 33 percent since mid-November. The volatility gauge climbed 1.1 percent yesterday to 16.21, a two-month high. It fell 4 percent to 15.57 at 9:36 a.m. in New York.
Almost 800,000 VIX options changed hands yesterday, 63 percent more than the 20-day average and the most in a month, Bloomberg data show. Total ownership of calls on the volatility gauge has risen to 5.96 million contracts, compared with 2.75 million puts.
“We are definitely seeing signs of caution in the options market,” Boris Lerner, a New York-based equity derivatives strategist at Morgan Stanley, wrote in a note to clients yesterday. “It seems that the recent pickup in vol is more of a punt on the upcoming FOMC meeting rather than a reflection of the broader investor’s concerns with the economy and equity markets.”
The options market is implying the S&P 500 will move 1.6 percent in either direction after the release of the FOMC statement today, Lerner said.
Jeffrey Lacker, president of the Richmond Fed and a critic of the Fed’s bond buying, said in a Dec. 9 speech he expects the Fed policy makers to discuss reducing purchases at this week’s meeting. Adding to the balance sheet “increases the risks” associated with exiting stimulus, he said.
The two declines for the VIX since Nov. 25 occurred after better-than-forecast jobs growth suggested the economy is strong enough to weather less monetary stimulus. The VIX slid 11 percent in the two-day drop following the Dec. 6 labor report.
Calls on the gauge with a strike level of 24 expiring in April had the largest increase in open interest over the past 16 trading days. The cost of the contract rose 15 cents to $1.05 in the past week. VIX December expiration is today before the open of regular trading.
Investors are prepared for a reduction in quantitative easing and volatility will probably decline as details are released about the Fed’s decision, according to Eric Augustyn, the Charlotte-based head of options strategy for Wells Fargo Private Bank.
“People are more in tune with what the Fed is going to do,” Augustyn, who helps manage $170 billion, said in a phone interview yesterday. "They know that the announcement is out there. Some investors were caught by surprise back in May. I think of the Fed as the boy who cried wolf, so from the market you may get a sigh of relief when it starts.’’
The S&P 500 lost 5.8 percent between May 21 and June 24 after the Fed signaled its asset-buying program could be trimmed should the U.S. economy show sustained improvement. The VIX, which climbs when traders anticipate more volatility, rose 50 percent during that period.
January futures on the VIX traded at 15.50 yesterday, about 4 percent below the spot level, according to data compiled by Bloomberg. The price relationship, known as backwardation, suggests concern about the immediate future because the cost of hedging against short-term price swings exceeds what traders are paying to shield themselves from volatility in the longer run.
Traders are also paying more for options to hedge against losses in the S&P 500 over the next month. Puts protecting against a 10 percent decline cost 9.6 points more than calls betting on a 10 percent rally, according to one-month implied volatility data compiled by Bloomberg. The price relationship, known as skew, is up from 3.6 points at the end of last month.
“The VIX is higher because people are hedging against what the Fed will say tomorrow,” said Donald Selkin, who helps manage about $3 billion as the New York-based chief market strategist at National Securities Corp. “People may be expecting some kind of volatility on the way down."
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