VIX Falls to Cheapest Since ’08 Before Earnings Reports

VIX Falls to Cheapest Since ’08 Before Earnings Reports
Traders work in the Volatility Index Options pit on the floor of the Chicago Board Options Exchange in Chicago, Illinois, U.S. Photographer: Tim Boyle/Bloomberg

The biggest June rally in U.S. stocks since 1999 has pushed options prices to the lowest level before any earnings season in almost four years even as analysts predict profits will fall.

The Chicago Board Options Exchange Volatility Index, which tracks the cost of contracts on the Standard & Poor’s 500 Index, has lost 36 percent since its 2012 peak last month. It slipped 6.8 percent below the S&P 500’s 20-day historical volatility, a measure of actual swings, on July 6, data compiled by Bloomberg show. That’s the cheapest contracts have been one trading day before Alcoa Inc. reports profit since October 2008.

Optimism that an agreement among European leaders on banks will help contain the region’s debt crisis and a 6 percent rally in the S&P 500 since June 1 has helped lower options prices, according to Scott Maidel of Russell Investments. The VIX has increased a median of 7.9 percent during the first month of second-quarter reporting periods dating back to 2002, according to data compiled by Bloomberg.

“We are just starting to see investors re-initiate hedges before earnings and as European concerns reemerge,” Maidel, who helps oversee $141 billion as a money manager for equity derivatives at Russell Investments in Seattle, said in a July 6 interview. “The low absolute level of VIX and a good price entry point for the S&P 500 make for a reasonable combination to seek downside protection.”

VIX, VStoxx

The VIX snapped a four-week streak of losses last week, rising 0.1 percent, after government data showed slower-than-forecast growth in U.S. payrolls and European Central Bank President Mario Draghi said the region’s economy remains weak. The volatility gauge was up 5.2 percent to 17.98 today. Europe’s VStoxx Index, a measure of Euro Stoxx 50 Index option prices, climbed 2.5 percent last week and added 0.1 percent to 25.6 today.

Alcoa begins the U.S. earnings season today with second-quarter results from the largest U.S. aluminum producer scheduled to be released after the close of regular trading. Analyst estimates compiled by Bloomberg project a 1.8 percent decline in profits for S&P 500 companies in the April-June period, which would mark the first year-over-year decrease since 2009, even as revenue increased 2.5 percent.

Option traders are increasing wagers that volatility will rise. The ratio of calls to buy the IPath S&P 500 VIX Short-Term Futures ETN relative to puts to sell rose to 0.79-to-1 on July 5, near its highest level since January, according to data compiled by Bloomberg. Ownership of calls to buy the U.S. exchange-traded note that tracks VIX futures rose 59 percent to 889,222 since the June 15 options expiration. During that time, open interest for puts added 30 percent to 1.13 million.

‘Downside Risks’

Investors will be gauging the effects of Europe’s debt crisis on U.S. results. Some “downside risks to the euro-area economic outlook have materialized,” Draghi said last week after ECB policy makers lowered the main refinancing rate to a record low of 0.75 percent and took the deposit rate to zero.

Global economic growth needs to improve for the VIX to remain at its current level, said Sequent Asset Management LLC’s Tim Hartzell. The volatility gauge is 17 percent below its 22-year average of 20.53.

“For the VIX to stay low we need to see a better China, a better Europe, better emerging markets leading to a better American economy,” Hartzell, who oversees about $350 million as chief investment officer at Sequent in Houston, said yesterday in a phone interview.

Economy Watch

The People’s Bank of China last week allowed banks to offer bigger discounts on loans, stepping up efforts to reverse a slowdown in the world’s second-biggest economy. The moves coincided with the ECB’s decision to reduce borrowing costs to a record low and the Bank of England’s expansion of asset purchases.

The U.S. economy is forecast to strengthen for the next two years, with gross domestic product rising 2.2 percent in 2012, 2.4 percent in 2013 and 2.8 percent in 2014, according to the median estimate from economists surveyed by Bloomberg.

Traders are speculating that lockstep moves among S&P 500 stocks will ease as more than half of the companies in the S&P 500 are due to announce quarterly profits this month. The CBOE S&P 500 Implied Correlation Index, a gauge that uses options to measure expectations about whether the 50 biggest S&P 500 stocks will move in unison, has lost 12 percent to 66.01 since a four-month high on June 13, data compiled by Bloomberg show. The index touched its lowest level since April on July 3.

The U.S. unemployment rate held at 8.2 percent in June, according to a Labor Department report last week. The Citigroup Economic Surprise Index for the U.S., which measures how much reports are missing or beating the median estimates in Bloomberg surveys, was at minus 62.50 on June 6, close to a 10-month low of minus 64.80 reached on June 21.

“It’s going to be a very uneven quarter,” Max Breier, a senior equity derivatives trader at BMO Capital Markets Corp. in New York, said in a July 6 phone interview. “I don’t think we’re out of the woods.”

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