Canadian stock investors have enjoyed the biggest rally in five years. Trading in the options market suggests further advances will be harder to come by.
Crude oil’s longest slump since 2009 and rising equity valuations have led traders to buy up protection against losses in the iShares Standard & Poor’s/TSX 60 Index exchange-traded fund, a measure of Canada’s largest companies. Investors are paying a premium for bets the index will fall, with the cost of puts on the ETF last month reaching the highest level on record relative to calls, data compiled by Bloomberg show.
Options trading shows investors are seeking to lock in gains after a rally that sent the S&P/TSX Composite Index to an all-time high. The Canadian equity benchmark fell 0.2 percent to 15,137.18 at 4 p.m. in Toronto, after the biggest drop in almost two weeks yesterday as signs of rising oil supply triggered losses among energy shares.
“We’ve had a nice run, so people are thinking, ‘To protect myself for the balance of the year, we’ll hedge,’” Shailesh Kshatriya, a senior investment analyst at Russell Investments Group, said in a June 27 interview in Toronto. His firm manages C$286.7 billion ($268.4 billion). “The TSX is trading at fair value. The fact that it’s not cheap makes it vulnerable to a pullback.”
The iShares S&P/TSX 60 ETF has rallied more than 11 percent this year, putting it on track for the biggest annual advance since 2009. The ETF, run by BlackRock Inc., is the biggest in Canada with about C$12.5 billion.
Investors have withdrawn C$1.38 billion from the ETF this year, the same as in all of 2010, data compiled by Bloomberg show. The redemptions are bigger than any other Canadian ETF and four times as much as the next closest fund, the Horizons S&P/TSX 60 ETF.
Seven of the 10 contracts on the iShares ETF with the highest ownership are puts, according to data compiled by Bloomberg. The put options with the highest open interest are December C$20.50 contracts and August C$21.50 puts. The ETF fell 0.1 percent to C$21.88 yesterday.
“The bearishness I think is protection, let’s protect what we’ve had up to this point,” Philip Petursson, director of institutional equities at Manulife Asset Management Ltd., said in a June 30 interview from Toronto. “This isn’t just retail investors trying to predict what’s going to happen over the next year or so, it’s also institutional investors taking a good, hard look at their portfolios.”
Puts with an exercise price 10 percent below the ETF cost 2.2 times more than calls betting on a 10 percent increase June 23, the most ever, according to two-month data compiled by Bloomberg. The price relationship known as skew has since dropped to 1.8.
Global central banks are supporting the economic recovery and Canadian stock valuations are reasonable, according to Ian Nakamoto, director of research at MacDougall MacDougall & MacTier Inc. in Toronto. The S&P/TSX trades at 20.6 times reported earnings, up from 18.7 at the beginning of the year, data compiled by Bloomberg show.
“We’re in a stretch where investors just can’t believe how good it is,” Nakamoto said by phone July 2. His firm manages about C$4.7 billion. “I think it continues to move up. What’s going to derail this market? It needs some kind of dart to poke that bubble, and I’m hard pressed to think of one.”
Energy stocks are vulnerable as conflicts in Ukraine and Iraq wax and wane and the end of a harsh North American winter leads to lower natural gas prices, according to Manulife’s Petursson. Oil and natural gas producers in the S&P/TSX yesterday capped the first three-day drop since May.
Libya has 7.5 million barrels of oil ready to export from the Es Sider and Ras Lanuf terminals after ending force majeure, the country’s Oil Ministry said yesterday. West Texas Intermediate crude has fallen over the past seven days, the longest losing streak since December 2009.
“We need to see earnings really, really ramp up to see the index move significantly higher,” Petursson said. Manulife manages about C$292 billion. “I’m not sure exactly where that comes from.”