Hedgers Swarm to S&P 500 With Equities at Record Levels: Options

Even with the Standard & Poor’s 500 Index at a record, evidence is mounting traders see no return of last year’s easy gains.

While the benchmark gauge pulled above an all-time closing high Friday, options market indicators are signaling a corresponding rise in skepticism. Take puts on the S&P 500, which pay off when the index falls. Traders have snapped up so many of the bearish contracts that their cost relative to bullish ones has jumped to the highest level since at least 2006.

Beneath the surface of the biggest equity rally since the dot-com bubble, institutions are taking steps to shield themselves should the momentum burn out. Turmoil in Europe and an unprecedented decline in oil are complicating the guessing game around Federal Reserve rate increases, says Peter Cecchini at Cantor Fitzgerald LP.

“Volatility is slowly creeping in from other asset classes and the rest of the world,” Cecchini, the New York-based chief strategist and global head of macro equity derivatives at Cantor Fitzgerald, said by phone Feb. 11. “People are beginning to hedge their books a little more because they don’t necessarily believe in this rally.”


The S&P 500 is up 209 percent since March 2009 and has gone more than three years without a retreat of 10 percent or more. But unlike last year, when the gauge never had a streak of losses that exceeded three days, the route higher in 2015 has seen repeated interruptions.

Daily swings in the S&P 500 have averaged 0.86 percent so far this year, compared with 0.53 percent in 2014, and the index has fallen on 16 out of 29 days, or 55 percent of the time. That compares with 43 percent in 2014.

The S&P 500 has rallied 5.1 percent in February after sinking 3.1 percent in January for its worst month in a year. Since the start of 2015, the index has experienced three declines of more than 2.7 percent, only to recover within a week each time, data compiled by Bloomberg show. The benchmark equity index climbed 0.4 percent to 2,096.99 at 4 p.m. in New York, above a record closing level of 2,090.57 reached Dec. 29.

Buffeted by fluctuations in oil and currencies, the Chicago Board Options Exchange Volatility Index, a measure of S&P 500 hedging costs, has averaged 18.5 this year, 30 percent higher than its mean of 14.2 in 2014. The gauge slid 4.2 percent to 14.69 in Friday’s trading.

‘Increasingly Nervous’

Right now, bearish options are 11.25 points more than bullish ones, according to three-month data compiled by Bloomberg. The gap, which widens as demand for stock market hedges grow, is 27 percent greater than it was on average when shares reached fresh records in 2014. After the S&P 500 erased four declines of 4 percent or more last year, the relationship known as skew was an average 8.9, the data show.

The average skew this year has been 11.68, greater than for any other year since at least 2006.

“Investors are getting increasingly nervous about a potential selloff,” Bill Merz, a strategist on the derivatives and structured products team at U.S. Bank Wealth Management, said by phone. His firm oversees $126 billion.

Hedge funds and other large speculators have pared positions that profit should the VIX decline, increasing the balance of those betting on a higher VIX to the most since at least 2004. These managers held about 87,000 long positions and 71,900 short ones in VIX futures through Feb. 3, Commodity Futures Trading Commission data show.

“The fact you’ve got all these uncertainties makes you feel like there’s better risk-reward to be net-long volatility than net short,” Justin Golden, a partner at Lake Hill Capital Management LLC in New York, said by phone Feb. 10. His firm trades options on equity indexes and commodities.

‘Caught Underexposed’

Even as investors snatch up hedges and abandon trades on lower volatility, professional forecasters on Wall Street are unanimous in seeing U.S. stocks gaining by the end of the year.

None of the strategists tracked by Bloomberg predicts a retreat in 2015, with the average estimate calling for a 7.2 percent advance from Feb. 12’s closing level of 2,088.48.

“Investors are focused on macroeconomic uncertainty and geopolitical risk, speculating that something is going to blow up,” Michael Corcelli, chief investment officer of hedge fund Alexander Alternative Capital LLC, said in a Feb. 12 interview. “As stocks grind higher, they will be caught underexposed, or even short.”

The elevated volatility this year could mean domestic stocks will have to weather deeper pullbacks, some more than 10 percent, according to Jim Strugger of MKM Holdings LLC. U.S. shares haven’t endured a decline of that magnitude, commonly referred to as a correction, since 2011.

“You have sustained elevation across multiple assets,” Strugger, a derivatives strategist at MKM in Stamford, Connecticut, said by phone Feb. 11. “That in and of itself is not only a risk in the short-term, but threatens to shift us back into a higher-volatility regime. I still think this could end badly.”

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