Traders are loading up on VIX (VIX) call options as history shows there’s a good chance stock-market volatility is about to increase.
Calls on the Chicago Board Options Exchange Volatility Index, which become more valuable during times of market stress, outnumbered ones betting on a decrease in market swings by 3.4-to-1 this month, the most since 2008, data compiled by Bloomberg show. The VIX has closed below 15 for the past 27 days. A study from Sundial Capital Research Inc. shows the gauge usually rises after reaching such low levels.
While investors are preparing for market turbulence, overall trading has been calm for most of the year with the Standard & Poor’s 500 Index (SPX) holding near a record. The tranquility won’t last much longer amid concerns over slowing economic growth and tensions between Russia and Ukraine, according to Donald Selkin, chief market strategist at National Securities Corp.
“There are lots of skeptics out there that think because of Ukraine or because gross domestic product was a bad number or because of earnings, stocks might be overvalued,” Selkin, who helps manage about $3 billion at National Securities, said in a May 22 phone interview from New York. “The possibility of a correction becomes greater.”
Traders use the VIX as a tool to protect their stock holdings from losses because the gauge moves in the opposite direction of the S&P 500 about 80 percent of the time. The measure tracks the cost of S&P 500 options, which become more expensive when expectations for volatility increase.
The VIX fell 8.7 percent last week to 11.36, closing about 2 points from an all-time low. There are about 5.5 million calls outstanding on the gauge, compared with 1.7 million puts, data compiled by Bloomberg show.
“Everybody has been expecting this VIX explosion and that’s indicative by the call open interest,” Todd Salamone, senior vice president of research at Schaeffer’s Investment Research, said May 22 via phone from Cincinnati. “That’s just an example of how cautious people are these days.”
Billionaire Petro Poroshenko won Ukraine’s presidential election held over the weekend, handing him the task of stemming deadly separatist violence that’s threatened to rip the former Soviet republic apart. Russian President Vladimir Putin, who doesn’t recognize the government in Kiev, has pledged to work with the winner. The U.S. and its allies said they’d tighten sanctions against Russia if voting was disrupted.
In the U.S. economy, bad weather and weak spending by lower-income consumers has led retailers to miss first-quarter earnings estimates by the widest margin in 13 years, according to a report last week from researcher Retail Metrics Inc.
The overall stock market has shrugged off any concerns this year about the economy or valuations. The S&P 500 jumped 1.2 percent last week to a record 1,900.53. The gauge trades at 17.5 times reported profit, near the highest level in four years.
The number of outstanding VIX calls is increasing partly because of popular strategies used to speculate that it will stay within a certain range, according to Rocky Fishman, equity derivatives strategist at Deutsche Bank AG in New York. One of those techniques is known as a call spread, when a trader buys options at one strike price and offsets the cost by selling contracts with a higher strike price.
“People don’t feel like they need to have the strongest possible protection because they don’t expect a large shock to the system,” Fishman said in a May 22 phone interview. “There is a lack of fear in the market.”
To Jason Goepfert, president of Sundial Capital, the VIX isn’t likely to remain at such low levels for much longer.
There have been 15 similar instances since 1986 when the VIX was under 15 at least a month and held at least 14 percent below its average level from the past 50 and 200 days, according to a May 21 report from the Blaine, Minnesota-based research firm. The VIX increased more than 20 percent every time in the next three months and increased a median of 45 percent at the highest points.
“It would be exceptionally unusual - unheard of, really - to not see a spike in volatility in the coming months,” Goepfert said in a note. “More likely sooner than later.”
To contact the reporter on this story: Callie Bost in New York at firstname.lastname@example.org