Concern they’ll be left out of a rally that’s propelled Japan’s Nikkei 225 Stock Average to an 18-year high is pushing investors into the options market.
Shareholders who aren’t willing to sell equities as valuations climb are buying puts instead, said Naoki Fujiwara, chief fund manager at Shinkin Asset Management Co. in Tokyo. Recent turmoil in China is another reason to purchase the contracts, he said. The cost of two-month puts that pay off if the Nikkei 225 drops 10 percent rose this month to the highest relative to calls since 2013.
The Nikkei 225 advanced to the highest since 1996 in June amid optimism about the earnings outlook and improvements in corporate governance. While concern about both China and the Federal Reserve has sent the equity gauge lower since then, the median forecast of analysts surveyed by Bloomberg is for a 5.8 percent gain by the end of 2015. The measure slid 0.1 percent at the close in Tokyo on Wednesday.
“There isn’t any negative news that stands out, but the market isn’t cheap,” said Fujiwara. “Declines in China’s markets don’t directly impact Japan, but it can’t escape getting dragged in as investors become ‘risk-off’ in the short term. Investors are dealing with the risk by buying puts rather than reducing their investments.”
China’s Shanghai Composite Index tumbled 8.5 percent on Monday, the sharpest fall since February 2007, amid concern government intervention to support the market is unsustainable. The Nikkei 225 dropped 1 percent the same day. The Japanese share gauge has climbed 16 percent in 2015, led by consumer and healthcare companies.
It’s valued at 19.2 times estimated profits, data compiled by Bloomberg show. That compares with 17.7 for the Standard & Poor’s 500 Index.
The Nikkei 225 fewer than 700 points away from breaking above 21,000, a level not seen since November 1996. When the gauge last closed at these heights, Japanese stocks were near the start of a slide that saw the measure sink 43 percent from June 1996 through an October 1998.
“It’s short-term hedging,” said Hiroaki Hiwada, a Tokyo-based strategist at Toyo Securities Co. “Investors are protecting themselves as pressure builds on the Nikkei with the index moving towards recent highs.”
Implied volatility, used to gauge the cost of options, for two-month contracts with an exercise price 10 percent below Nikkei 225 was 22.6 on Monday, compared with 15.4 for calls 10 percent above, according to data compiled by Bloomberg. The gap widened to 7.9 points on on July 10, the most since March 2013.
The Nikkei Volatility Index, which tracks the cost of options on the underlying gauge, climbed 1.5 percent on Tuesday.
Investors are buying Nikkei 225 puts to shield their investments from the impact of the first U.S. interest-rate increase since 2006, expected as soon as September, according to Toyo Securities and Shinkin Asset.
For BNP Paribas SA, the options market shows concern that deteriorating global risk sentiment will boost the yen, weighing on Japanese equities.
The Nikkei 225 closed at 20,328.89 on Tuesday, down 2.6 percent from its June peak as Greece’s debt crisis, China’s stock-market meltdown and a commodity slump drove global equities lower.
“Investors started to worry about a potential ‘risk-off’ combined with a potential yen appreciation and the fact that the Nikkei was above 20,000,” said Guillaume Derville, head of Asia Pacific equity derivatives strategy at BNP Paribas. “This offered good entry points on such hedging strategies.”
Investors are positive on Japanese equities in the long term. Valuations are still attractive and corporate Japan is more focused on improving returns, according to Henderson Global Investors Ltd., while Schroders Plc says the economic outlook is brighter and policy is supportive of stocks.
“People are grudgingly looking at the Japanese market, saying I really missed out and I can’t afford to miss out further,” said Stefan Hofer, the Hong Kong-based chief investment strategist at BNP Paribas Wealth Management. “You’re going to see over the course of this year gradual increases in overall Japanese equity allocation. The long-term structural outlook for Japanese equities is very positive.”