Investors haven’t seen this much volatility in U.S. stocks since April, and options traders are betting there’s more to come.
The Chicago Board Options Exchange Volatility Index jumped 17 percent to 12.08 last week and a similar measure for European equities surged the most in almost six months. The ratio of contracts wagering that the volatility measure known as the VIX will rise versus those betting on declines is almost 4-to-1, the highest level since before the financial crisis in 2007, according to data compiled by Bloomberg.
“Fear always comes in waves,” Randy Warren, who manages more than $100 million at Exton, Pennsylvania-based Warren Financial Service and Associates Inc., said by phone on July 11. “Over the course of 60 to 90 days, things could get pretty ugly. You could actually see the VIX well into the 20s, 30s, maybe even the 40s.”
More than $1 trillion has been wiped from the value of global stocks since a peak on July 3 as signs of financial stress at a Portuguese bank and speculation the recent rally is overdone pulled stocks down from record levels. Raymond James & Associates Inc. last week said stocks are vulnerable to losses and Citigroup Inc.’s chief U.S. equity strategist cited concerns for a “severe” pullback.
The Standard & Poor’s 500 Index slid 0.9 percent last week and the Stoxx Europe 600 Index dropped 3.2 percent, the worst declines in at least three months for each. Goldman Sachs Group Inc. moved forward its estimated start of Federal Reserve interest-rate increases and the parent company of Banco Espirito Santo SA, Portugal’s second-largest lender, missed a debt payment.
“I think the illusion that things have improved considerably in Europe is about to be shattered,” Jeffrey Sica, president of Morristown, New Jersey-based Sica Wealth Management LLC, said in a phone interview on July 11. “Investors in the U.S. will begin to have to contend with the possibility of another drastic slowdown in Europe soon.”
Earnings for companies in the S&P 500 expanded 4.5 percent last quarter, according to analysts’ estimates compiled by Bloomberg that have decreased from forecasts as high as 7.3 percent in April.
The rebound in volatility last week followed a drop in both the U.S. and European benchmark options gauges to the lowest levels in more than seven years. Each is still down more than 5 percent this year as the Fed and European Central Bank reiterated commitments to accommodative monetary policy.
The VIX, which moves in the opposite direction of the S&P 500 about 80 percent of the time, rose to 12.08 at the end of last week from 10.32 on July 3. The VStoxx Index, tracking options on the Euro Stoxx 50 Index, climbed to 16.34 last week from 12.71 on June 19, the lowest level since 2006.
The VIX fell 2.2 percent to 11.82 at 4 p.m. in New York. The VStoxx decreased 8.3 percent to 14.99.
“The volatility levels have been driven by central banks and low interest-rate policies,” Juergen Lanzer, a portfolio manager on the global equities team at Alliance Trust, said in an interview. “It has hit a historical low, but it won’t stay forever. In the long term, it has to normalize at some point.”
The S&P 500 hasn’t risen or fallen 1 percent on a closing basis since April 16, the longest streak of calm since 1995.
Investors have been building up protection against potential market pullbacks as both U.S. and European stock markets trade near their highs of the year. The S&P 500, which reached the highest price-to-earnings valuation since 2010 at its last record, has not had a drop of 10 percent in more than two years.
Traders own 2.1 bearish options on the S&P 500 for every bullish one, around the most since 2008. About 3.7 options betting on upside in the VIX are owned for every one wagering on its decline, the highest call-to-put ratio for the contracts since before the financial crisis.
Options betting on a 10 percent drop in the S&P 500 cost 7.56 points more than ones wagering on a 10 percent rise, according to six-month data compiled by Bloomberg. That’s around the widest spread in a year, indicating that demand has picked up for protection against a pullback in equities.
Contracts betting on the future direction of the VIX are not forecasting any big moves in the next few months, according to Dominic Salvino, a specialist on the CBOE floor for Group One Trading, the primary market maker for VIX options.
Futures on the volatility gauge expiring this month ended last week 4.7 percent higher than the VIX’s closing price of 12.08 last week, according to data compiled by Bloomberg. Contracts expiring in August and September both closed with prices at or below 13.9, the volatility gauge’s average over the past 12 months.
“The curve is pretty flat right now,” Salvino said by phone July 11 from Chicago. “You had a big move in futures from the Portugal news, but the market has shrugged it off. There’s not much on the horizon that people are afraid of.”
Still, signs of debt troubles in Europe have some traders wondering if the situation could reach a magnitude similar to the European and U.S. sovereign credit turbulence in 2011. During that year, the VIX more than tripled from its April low to a high of 48 in August and the S&P 500 plunged as much as 19 percent. The VStoxx climbed 190 percent from its low to its high in 2011 as the Stoxx 600 Index dropped as much as 26 percent.
“Volatilities in the S&P 500 are very sensitive, which has not been the case for some time,” Mark Caffray, who brokers options for clients at Chicago-based PTR Inc., said by phone July 11. “This could be a sign of a temporary market top.”