First Hint of U.S. Stock Losses Fuels Rush for Insurance

After three years of non-stop gains in the U.S. stock market, investors are loading up on insurance at the first sign of trouble.

An index that tracks the cost of options used to hedge against a plunge in the Standard & Poor’s 500 Index has jumped to the highest level in almost 16 years, according to data compiled by Bloomberg. Stocks fell and volatility surged yesterday, sending the benchmark gauge for U.S. equities to its biggest loss in seven weeks, on concern over the outlook for Chinese stimulus and the health of the U.S. economy.

Speculative stocks have suffered bigger losses as investors sold their best performers and companies with the highest valuations. When the Russell 3000 Index touched an intraday record at the end of last week, fewer than 55 percent of its components traded above their 200-day moving average, a combination that hasn’t happened since the peak of the dot-com bubble, according to MKM Partners LLC.

“There are signs of excess,” Scott Maidel, an equity-derivatives money manager in Seattle at Russell Investments, said in an interview. “The longer we go without a meaningful downside correction, the higher probability it will occur and the higher probability it would be more meaningful.”

The S&P 500 fell 0.8 percent yesterday as sales of existing homes in the U.S. unexpectedly dropped and China’s finance minister damped stimulus speculation. The gauge is up almost 60 percent since the end of 2011. The Russell 2000 Index slid 1.5 percent yesterday, bringing its decline since Sept. 18 to 2.6 percent, the largest two-day retreat since Aug. 1.

Skew Index

Concern that the losses will worsen has increased demand for shorter-dated, out-of-the-money options designed to protect a portfolio’s value. The Chicago Board Options Exchange’s SKEW Index, which tracks expectations for an outsized drop in U.S. stocks known as tail risk, reached 146.08 Sept. 19, the highest level since October 1998. It slipped to 139.85 yesterday.

The gauge has averaged 129.77 over the past 12 months, compared with a mean of 122.82 during the past five years, data compiled by Bloomberg show. A level of 100 implies there’s a negligible risk of a stock-market selloff, according to CBOE.

“Investors increasingly understand that hedging is the price of staying long the bull market,” Jim Strugger, a derivatives strategist at Stamford, Connecticut-based MKM Holdings LLC, said in an interview.

Bearish Options

Strugger pointed to an increase in the number of bearish options on the SPDR S&P 500 exchange-traded fund relative to bullish ones. The ratio is currently 3.3-to-1, the second-highest level since 2010, according to data compiled by Bloomberg.

Brief retreats in the stock market have become common over the past three years and investors have seen the S&P 500 quickly bounce back from any slump. The benchmark gauge hasn’t had a four-day slide this year and hasn’t fallen 10 percent in three years.

There’s a good chance U.S. equities will decline over the next few weeks, based on the market’s deteriorating breadth, according to a research report from Jonathan Krinsky, chief market technician at MKM Partners. The last time so few companies in the Russell 3000 helped push the gauge to an intraday high was March 24, 2000, the report showed.

The CBOE Volatility Index jumped 6.4 percent to 14.56 at 9:38 a.m. in New York. The gauge of S&P 500 derivatives known as the VIX surged 13 percent to 13.69 yesterday, its biggest one-day advance since July.

“People are looking for an excuse to knock the market back down a little bit,” Donald Selkin, chief market strategist for New York-based National Securities Corp., which oversees about $3 billion, said in a phone interview. “Maybe the feeling is that we might finally be ready for a more serious down move.”

Before it's here, it's on the Bloomberg Terminal.