U.S. equity option costs climbed to the highest levels in almost a year relative to Treasuries, oil and gold, pushed up by traders betting stocks are more vulnerable to Federal Reserve tapering after rallying the most.
Implied volatility on the SPDR S&P 500 ETF Trust (SPY) is 18 percent higher than for the iShares 20+ Year Treasury Bond ETF, according to three-month data compiled by Bloomberg. That’s close to the biggest premium since August 2010 and higher than 90 percent of the time in the past two years. The measure of price swings in the equity fund this month reached the most since November 2008 relative to the U.S. Oil Fund LP (USO) and a 10-month high versus the SPDR Gold Shares. (GLD)
Concern in the options market is greater toward shares after the Standard & Poor’s 500 Index gained 30 percent in 2013, beating Treasuries and commodities. While markets have rebounded after almost $3 trillion was erased from global stock values at the end of January, the cost of protecting against losses will probably remain higher than last year as the American bull market enters its sixth year in March, said Abi Oladimeji, head of investment strategy at Thomas Miller Investment Ltd.
“We would expect returns for risk assets to be notably lower in 2014 than last year with volatility notably higher,” Oladimeji, who helps oversee $4.3 billion as head of investment strategy at his firm in London, said in a phone interview yesterday. “There is a lot of room for disappointment.”
The S&P 500 jumped the most since 1997 last year and reached an all-time high of 1,848.38 on Jan. 15. The MSCI All-Country World Index advanced 20 percent in 2013. Gains in equities came as bonds worldwide posted the first loss since 1999, gold slumped 28 percent and West Texas Intermediate, the U.S. benchmark oil contract, advanced 7.2 percent.
A selloff in currencies from Argentina to Turkey, South Africa and Indonesia, as well as concern that reduced monetary stimulus and a potential slowdown in China will hamper global expansion, triggered this year’s stock retreat. Some investors abandoned riskier assets, sending the S&P 500 down 3.6 percent last month for its biggest January decline since 2010. Bonds beat stocks for the first time since August and gold rallied 3.2 percent in January.
Equity losses spurred a jump in stock volatility after it hovered near its lowest level since 2007 last year. The Chicago Board Options Exchange Volatility Index, the gauge of S&P 500 options prices known as the VIX (VIX), climbed 34 percent in January, the most since May 2012, and advanced to a 13-month high on Feb. 3. The VIX and the S&P 500 move in opposite directions about 80 percent of the time.
Bets on higher equity volatility have backfired in the past. Investors were whipsawed in October when traders shrugged off concern over U.S. budget negotiations and the economy. The iPath S&P 500 VIX Short-Term Futures ETN, the most-traded security that tracks U.S. stock swings, jumped 20 percent in five days, then wiped out that gain in the following week.
Global stocks have erased losses for the year amid growing confidence in the U.S. economy and a rally in emerging markets. The value of shares around the world climbed to $62.1 trillion on Feb. 17, exceeding the level at the end of December and rebounding from this year’s low of about $59 trillion on Feb. 4, data compiled by Bloomberg show.
“You don’t have to be a rocket scientist to see the risk-return in equities is very good,” said Tim Short, who helps oversee about $1.2 billion as chief risk officer at City Financial in London. “There is more risk to government-bond markets than possibly to equity markets in the current unconventional monetary policy environment.”
Earnings yield, a valuation measure showing the proportion of profits to share prices, is 5.9 percent in the S&P 500, data compiled by Bloomberg show. That compares with the yield on 10-year U.S. Treasuries of 2.7 percent. Wall Street strategists predict the equities gauge will gain about 6 percent this year, based on the average of 21 projections compiled by Bloomberg.
Gilles Guibout at AXA Investment Managers in Paris said equity volatility is so low that it wouldn’t take much to push it up. The VIX rose 12 percent to 15.50 today after falling for two consecutive weeks. It’s dropped 35 percent from its high on Feb. 3 through yesterday. Europe’s VStoxx Index climbed 2.1 percent to 17.45 today.
Bank of America Merrill Lynch’s MOVE Index, which measures volatility based on prices of over-the-counter options on Treasuries maturing in two to 30 years, slid 2.3 percent to 55.99 yesterday, while the CBOE Crude Oil Volatility Index advanced 2.7 percent to 18.43 and the CBOE Gold ETF Volatility Index gained 0.1 percent to 16.28.
“You have quite an obvious consensus” that equities will do well, Guibout, who helps oversee $737 billion from Paris, said in an interview yesterday. “Any grain of sand can debase the expectations.”
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