Paranoia Squashed as VIX Sinks Most in Two Months on Fed

Photographer: Tim Boyle/Bloomberg

Traders work on the floor of the Chicago Board Options Exchange (CBOE) in Chicago. Close

Traders work on the floor of the Chicago Board Options Exchange (CBOE) in Chicago.

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Photographer: Tim Boyle/Bloomberg

Traders work on the floor of the Chicago Board Options Exchange (CBOE) in Chicago.

Another bout of market paranoia came to nothing yesterday as stock investors looked past reduced Federal Reserve stimulus and focused on assurances that interest rates would stay near zero percent.

The cost of protecting against equity losses as measured by the Chicago Board Options Exchange Volatility Index slid 15 percent, the biggest drop in two months, as the Standard & Poor’s 500 Index jumped 1.7 percent. Six of the seven biggest declines in the VIX since the start of 2012 have occurred this year after concerns from government shutdowns to slowing profit growth failed to shake bulls, data compiled by Bloomberg show.

Options used to hedge U.S. equity declines are cheaper than almost any time in the past five years, a sign investors are confident more stock-market gains are coming after a 168 percent advance since March 2009. The S&P 500 (SPX) erased losses for December as Fed policy makers said they had enough faith in the labor market to reduce monthly bond purchases by $10 billion and Chairman Ben S. Bernanke promised to keep interest rates low.

“It’s confirmation that the Fed thinks the economy is strong enough to justify tapering,” David Lafferty, chief investment strategist for Natixis Global Asset Management in Boston, said yesterday in a phone interview from Boston. His firm oversees $783 billion. “It’s now so expected and well telegraphed by the Fed that ironically it’s removing the uncertainty. That’s why the VIX is coming down.”

Stock Records

The S&P 500 rose to 1,810.65 and the Dow Jones Industrial Average (INDU) soared 292.71 points to 16,167.97 as both gauges reached records. The VIX fell to 13.80 in the sixth biggest retreat for the volatility gauge in the past two years. Ten-year Treasury yields added six basis points to 2.89 percent, while the dollar jumped to a five-year high versus the yen and climbed versus most major peers.

The VIX lost 6.6 percent to 12.89 at 10:59 a.m. in New York today.

The Fed took its first step toward unwinding the unprecedented stimulus that Bernanke put in place to help the economy recover from the worst recession since the 1930s. Fed officials raised their assessment of the outlook for the job market, predicting the unemployment rate will fall as low as 6.3 percent by the end of next year, compared with a September projection of 6.4 percent to 6.8 percent.

Equity Options

The central bank has quadrupled its assets since 2008 with bond purchases to reduce borrowing costs and boost economic growth, helping send the S&P 500 up 27 percent this year, the biggest increase since 1997. Before the Fed statement, traders piled into options to protect against stock losses, pushing the VIX higher in 14 of the 16 days since Nov. 25, a record-long streak.

The VIX, calculated using S&P 500 options expiring over the next 30 days, had jumped more than 30 percent since mid-November through Dec. 17, data compiled by Bloomberg show. The advance in volatility comes during one of the calmest equity markets this decade as Fed stimulus helped suppress risk perceptions.

Calls that pay should the S&P 500 advance 10 percent cost 8.03 points more than puts hedging against a 10 percent decline, according to three-month data compiled by Bloomberg. The price relationship known as skew is about 13 percent below the average since 2009.

‘Renewed Legs’

“We will likely see some consolidation of this move, but I do think this likely paves the way for a constructive equity environment into year’s end,” Michael Purves, chief global strategist at Weeden & Co. in Greenwich, Connecticut, wrote yesterday in a note to clients. “The performance chase should have renewed legs now.”

The VIX has averaged about 14.3 a day this year, the lowest reading since 2006, data compiled by Bloomberg show. The gauge has closed below its historic mean of 20.20 on all but two days of the year.

The economy will probably remain too weak to support gains in stocks as the Fed cuts stimulus, according to Peter Cecchini, chief strategist and global head of macro equity derivatives at New York-based Cantor Fitzgerald LP.

The “taper will be a net negative for the market over the next several months,” Cecchini said yesterday in an interview. “The whole idea that growth will support a second leg of the recovery is not supported by data. Growth is still too low.”

The U.S., the world’s biggest economy, is projected to grow 2.6 percent in 2014, according to economist forecasts compiled by Bloomberg. That’s below the 3 percent average from 1990 to 2007 before the last recession began.

VIX Calls

Investors added almost 1.3 million VIX call options from Nov. 25 through Dec. 17, compared with about 139,000 puts. The index is used as an equity hedge since it moves in the opposite direction of the S&P 500 about 80 percent of the time.

The CBOE S&P 500 Short-Term Volatility Index, tracking nine-day options on the stock gauge, plunged 24 percent to 12.95 yesterday, the biggest retreat since Oct. 16. The VVIX Index, a measure of VIX swings, fell the most since 2006 as it lost 18 percent to 67.17. The measure was at a 14-month high in October.

“Taper is not tightening and the Fed has been able to communicate that difference,” Trevor Mottl, Susquehanna Financial Group LLLP’s New York-based head of derivatives strategy, said yesterday in phone interview. “The VIX is down because you’re effectively able to stimulate the economy in the front end through the lower rates, while keeping the risk of bubbles down in the back end through tapering.”

To contact the reporter on this story: Nikolaj Gammeltoft in New York at ngammeltoft@bloomberg.net

To contact the editor responsible for this story: Lynn Thomasson at lthomasson@bloomberg.net

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