Biggest Stock Market Drop in Month Awakens Haven Trades

Faced with signs of financial market stress, traders are rushing back to the options market.

They’re piling into exchange-traded products tied to stock volatility, with more than 60 million shares of the iPath S&P 500 VIX Short-Term Futures ETN changing hands yesterday. That made the security that rises when equity swings increase the fourth-most active U.S. exchange-traded fund. They’re also adding to bets on gold: bullish contracts on an ETF tracking the metal cost the most in a year relative to bearish ones.

Record prices for U.S. stocks are pushing up demand for protection as Ukrainian tensions rise and data on everything from China’s industrial production to its retail sales show weakening growth. The Standard & Poor’s 500 Index (SPX) erased its gain for the year yesterday, falling 1.2 percent for the biggest retreat since Feb. 3, and gold reached a six-month high.

“The key risk we’re focused on is ultimately Ukraine,” Jason Benowitz, a senior portfolio manager who helps oversee about $4.7 billion at Roosevelt Investment Group Inc. in New York, said in a phone interview. “To the extent this could lead to either material economic sanctions or in fact armed conflict, either of these will certainly be headwinds.”

Bull Market

U.S. stocks are falling at the five-year anniversary of a bull market that sent the S&P 500 up 173 percent, pushing its price-earnings ratio to 17 -- close to the level where equities peaked in 2008. The advance is about a week away from supplanting the stretch of equity gains that lasted from 1982 to 1987 to become the fifth longest of all time, according to Bespoke Investment Group LLC.

Secretary of State John Kerry warned yesterday there could be “very serious” steps from Europe and the U.S. if there is no sign of a resolution between Ukraine and Russia as Crimea prepares to vote this weekend on a separatist resolution. China’s industrial output, investment and retail-sales growth cooled more than estimated in January and February.

Volatility securities become more valuable when market swings increase, luring traders looking to protect gains in equities. The iPath S&P 500 VIX Short-Term Futures ETN, known by its ticker symbol VXX (VXX), is designed to generate the daily return of a gauge tracking futures on the Chicago Board Options Exchange Volatility Index. The VIX moves in the opposite direction of the S&P 500 about 80 percent of the time.

Higher Volatility

“Uncertainty about macro-economic data, China defaults and Russia uncertainty all seem to be coming to the front page at the same time,” Scott Maidel, a senior portfolio manager for equity derivatives at Russell Investments in Seattle, wrote in an e-mail. “Anything like this could lead to even higher volatility.”

Bullion advanced 14 percent this year, rebounding from the biggest annual drop since 1981. Gold for April delivery added 0.1 percent to settle at $1,372.40 an ounce on the Comex yesterday, the highest close since Sept. 9.

Holdings through gold exchange-traded products rose in February for the first time since 2012. Assets in the SPDR Gold Trust have climbed 1.6 percent in 2014 after a 41 percent plunge last year that erased $41.8 billion in value.

“The precious metal has become the outlet for many investors who don’t want to look at Treasuries and realize that the equity-market rally could stall,” said Kevin Mahn, the Parsippany, New Jersey-based president of Hennion & Walsh Asset Management, which oversees more than $600 million. “Concern about China slowing down is another reason to be in gold. Also, the Crimea tension pushed prices higher.”

Crimea Votes

Bullish options on the gold ETF are the most expensive since March 2013. Calls betting on a 10 percent increase in the fund cost 0.8 point less than corresponding puts, according to three-month implied volatility data compiled by Bloomberg.

The appeal of gold will decrease once the Ukraine situation stabilizes, according to Peter Jankovskis of OakBrook Investments LLC. The Russian-speaking region of Crimea will hold a referendum March 16 on whether to split from Ukraine. The European Union and the U.S. are trying to use sanctions to force Russian President Vladimir Putin to retreat.

“The flight to safety because of Ukraine helped gold, but once they find a resolution and the situation eases the premium will come off,” said Jankovskis, who helps oversee $3.4 billion as co-chief investment officer of Lisle, Illinois-based OakBrook.

Fund Flows

Not everyone is jumping back in. Assets into funds backed by precious metals have increased by 1.2 percent this year even as prices jumped. Last year, the funds saw a 36 percent withdrawal as prices slumped 28 percent, data compiled by Bloomberg show.

The Chicago Board Options Exchange Gold ETF Volatility Index, a measure of options costs on the fund, rose 3.8 percent to 17.30 yesterday. The CBOE Volatility Index of S&P 500 derivatives prices advanced 12 percent to 16.22. Europe’s VStoxx Index climbed 3.3 percent to 22.82 at 8:18 a.m. in London today.

“There has been flight to quality because of emerging-market issues and political tensions,” James Paulsen, chief investment strategist at Wells Capital Management, said by phone from Minneapolis. His firm oversees about $360 billion. “Whenever something worries you, buy gold.”

To contact the reporters on this story: Debarati Roy in New York at droy5@bloomberg.net; Trista Kelley in London at tkelley2@bloomberg.net

To contact the editors responsible for this story: Cecile Vannucci at cvannucci1@bloomberg.net Lynn Thomasson

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