Swiss Stocks Blindside Traders as Volatility Soars 66%: Options

If anyone saw Switzerland’s central bank coming, they didn’t do much about it in the options market.

A contract that paid out should the benchmark Swiss Market Index drop to 8,150 by today from around 9,200 had no volume for the last week. That changed yesterday, when the Swiss National Bank’s move to abandon its currency peg against the euro sent shock waves through markets. A rout in Swiss equities spurred traders to snap up 4,300 of the puts in a matter of hours, sending the price soaring from a few centimes to more than 15 francs -- a jump of about 15,000 percent.

“Nobody saw it coming, primarily because central banks are supposed to signal policy changes,” said Guy Foster, the head of research at Brewin Dolphin Securities Ltd. in London. “I suspect the SNB did not expect such a violent currency appreciation.”

The Swiss Market Index tumbled for a second day, still reeling from the SNB’s decision to abandon its 1.20 franc-per-euro cap that sent the franc soaring as much as 41 percent against the euro. The shift may have been an attempt by the SNB to preempt possible pressure on the franc in the event of government bond purchases by the European Central Bank. In a nation that has attracted investors for its stability, the change underscores challenge Swiss policy makers have faced managing a currency popular with investors at times of crisis.

UBS AG, Holcim Ltd. and Swatch Group AG were among shares tumbling at least 10 percent, while the VSMI, the measure that tracks volatility expectations for the SMI, posted a record 66 percent gain since the SNB move. The VSMI is calculated using options contracts denominated in francs.

Those trading in currency options had also made wrong-way bets, wagering for the last three years that the dollar will rise against the Swiss franc. The 25-delta three-month risk reversal rate was at a premium for dollar calls on Jan. 14, which grant the right to buy the currency against the franc.

For Citigroup Inc.’s Jonathan Stubbs, yesterday’s reaction was too extreme.

“The sharp drop in the SMI provides a buy-the-dip opportunity,” said Stubbs, head of European and U.K. equity strategy at Citigroup in London. “A stronger CHF is going to present an immediate hit to Swiss corporate earnings, but we believe that share prices have quickly priced in a significant portion of this.”

Still, with reverberations of the decision reaching across asset classes globally, the SNB’s U-turn may change the perception of an institution known for its reliability.

“The Swiss central bank has shown how powerful surprise is as a tool for central banks, and how dangerous complacency can be for investors,” said Justin Urquhart Stewart, who helps oversee about $10 billion at Seven Investment Management LLP in London. “No one has been watching the Swiss-euro peg, having assumed that it was here to stay for a long while.”

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