The longest winning streak for the Dow Jones Industrial Average this year and a wave of corporate deals has options traders lining up bets on a return to market tranquility.
The Chicago Board Options Exchange Volatility Index is within three points of a record low after the Standard & Poor’s 500 Index added 4.5 percent since April 11. The cost of betting on market turbulence in the next month has fallen to a four-year low, data compiled by Bloomberg show. The drop shows demand for VIX options is evaporating as investors decide they don’t need the contracts used to protect the value of their stock holdings.
The S&P 500 reached an all-time high this week as Hillshire Brands Co. agreed to buy Pinnacle Foods Inc. for $4.3 billion and Coca-Cola Co. boosted its stake in Keurig Green Mountain Inc. Netflix Inc., Facebook Inc. and Tesla Motors Inc. have risen at least 5.4 percent in the past three days on speculation declines in technology shares had been overdone.
“Previous notions of where the floor is on the VIX are at risk of being wrong,” Max Breier, a senior equity-derivatives trader at BMO Capital Markets Corp. in New York, said by phone May 13. “The situation in Russia has become sort of an afterthought and the economic data has turned around a bit.”
Russia’s Micex Index has rallied for the past five days as President Vladimir Putin said he pulled back troops from Ukraine’s border and called for more dialogue. Economic data yesterday showed spending at U.S. retailers held steady in April after a surge in the previous month. Small businesses were more upbeat in April than at any time since before the last recession, another report showed.
The VIX, which measures the cost of contracts on the S&P 500, fell 0.8 percent to 12.13 yesterday, the lowest level since August. It is 40 percent below its five-year average. The gauge rose 0.7 percent to 12.22 at 4 p.m. today in New York. Europe’s VStoxx Index fell 0.8 percent to 15.88.
There’s not much demand for protection on the S&P 500 because the gauge has held up well compared with measures for small-cap stocks and technology companies, according to Stephen Solaka, who helps oversee about $145 million as managing partner of Belmont Capital Group in Los Angeles. The Russell 2000 Index is still 7.2 percent below its all-time high in March, while the Nasdaq Composite Index is 5.2 percent from a 14-year high reached the same month.
Contracts betting on a 10 percent decline in the VIX in the next month cost 3 points less than those wagering on a 10 percent rise, according to data compiled by Bloomberg. That’s the lowest difference in cost between the two since January 2010.
Investors have added $504 million to U.S. equity exchange-traded funds in the five days through May 12, data compiled by Bloomberg show. Energy stocks saw the most money added among industry ETFs, increasing $301 million during the past week. Technology ETFs had $808 million in outflows over the same period.
The U.S. stock market will be volatile because shares of small companies are still too expensive and equities tend to decline before midterm elections, according to Jim Russell, a senior equity strategist of U.S. Bank Wealth Management. The Russell 2000 trades at 25.2 times estimated earnings, 57 percent more than the multiple for the S&P 500, data compiled by Bloomberg show.
“We do feel that the market is correcting through the year, although it’s not evident yet,” Russell, whose firm oversees $120 billion, said by phone yesterday. “There’s a saying ’sell in May and go away.’ We’re concerned about the potential for seasonal downside from May to September.”
Nine of the 10 most-owned options on the VIX are betting on a rise in volatility. Calls expiring May 21 with a strike price of 16 had the most open interest among contracts, followed by calls with a strike price of 22 expiring on the same day.
A decline in a measure of swings in the benchmark for U.S. options prices is a bullish sign for equities, Jim Strugger, a derivatives strategist at MKM Partners LLC, wrote in a research report yesterday. Financials and industrial stocks may regain momentum as utilities and consumer shares lag, he said. The VVIX Index, tracking contracts whose value is tied to fluctuations in the VIX, has dropped 13 percent this year to the lowest since 2008.
“There’s not a lot of really negative things going on in the market aside from the issues in Ukraine and even that has settled down,” Randy Frederick, managing director of trading and derivatives at Charles Schwab Corp., said by phone May 12. The firm oversees $2.3 trillion in client assets. “There’s stability in momentum names.”