Bearish ETF Bets Soar as Canada Stocks Climb Back Toward RecordEric Lam
As Canadian stocks climb back toward an all-time high, concern that oil’s collapse will take a toll on the economy is sending investors in search of protection.
Bearish bets for the iShares Standard & Poor’s/TSX 60 Index exchange-traded fund, Canada’s largest ETF by assets, have surged this year to as much as nine times the number of calls. The ratio reached the highest level ever on March 20, according to data compiled by Bloomberg.
Investors remain wary amid a 3.2 percent rally in the Canadian equity market this month as energy companies, the worst performers in the broader S&P/TSX Composite Index last year, have rebounded 2.9 percent in 2015. A more than 50 percent drop in crude prices coupled with a potential housing bubble still could damage the nation’s economic recovery, according to Nick Piquard, an options strategist at Horizons ETFs Management Canada Inc. in Toronto.
“We have significant commodity exposure and an expensive housing market,” said Piquard, whose firm oversees about C$4.4 billion ($3.5 billion) in ETF products. “With energy slowing down, it’s been a huge driver for our growth and our jobs the past few years.”
The S&P/TSX climbed for seven straight days through last Friday, the longest winning streak since June, when oil prices began their slide into a bear market. A 5.1 percent rally since a low on March 10 has put the Canadian equities benchmark within 1.8 percent from recapturing an all-time high. The index dropped 0.1 percent to 15,361.48 at 9:54 a.m. in Toronto.
The index reached a high of 15,657.63 on Sept. 3, with consumer-staples, industrial and energy shares leading the way with gains of more than 18 percent, only to begin plunging as crude slumped amid a glut of U.S. shale production and concerns of slowing demand from markets in Europe and China. Equities plummeted as much as 12 percent through the rest of the year, with the S&P/TSX Energy Index ending 2015 with a 7.8 percent loss, the worst decline in three years.
Bearish bets on the iShares S&P/TSX 60 ETF that pay out on a 10 percent drop cost 10.4 points more than contracts betting on a 10 percent advance, according to three-month data. The ratio on March 18 was 11.36, the highest since June 2012.
All of the 10 most-owned options on the ETF are puts. The two contracts with the highest ownership expire in May.
Energy producers and banks account for almost half of the S&P/TSX 60, which tracks the nation’s 60 largest and most liquid stocks including Suncor Energy Inc. and Royal Bank of Canada.
Alex Kosoglyadov, vice president of equity derivatives at BMO Capital Markets Corp. in New York, said an increasing number of clients in Canada and the U.S. are buying puts in the iShares S&P/TSX 60 ETF to both hedge positions and make a negative call with an eye to economic threats on the horizon.
“Since the start of 2014, sentiment in the Canadian equity market has become much more bearish,” he said in a phone interview. “We’ve definitely seen a pick-up in interest in Canadian markets from U.S.-based accounts.”
Canada’s economy is forecast to grow 1.9 percent this year, the slowest rate in six years. Bank of Canada Governor Stephen Poloz has warned that consumer debt and house prices that are as much as 30 percent overvalued are the two biggest risks to Canada’s economy.
The central bank also unexpectedly cut interest rates in January to counter the slump in oil -- the nation’s biggest export. The near record-low interest rates have fueled increased margin investing among Canadians, a strategy that carries greater risk.
Canadians borrowed C$19.2 billion against their brokerage accounts in January, near a peak of C$19.4 billion in September according to figures from the Investment Industry Regulatory Organization of Canada.
Thomas Caldwell, chairman of Caldwell Securities Ltd. in Toronto, which manages about C$1 billion, said a weakening Canadian dollar has made the S&P/TSX more attractive again and he is buying energy stocks including Suncor, Canadian Natural Resources Ltd. and Encana Corp.
“It’s about taking the long view,” Caldwell said. “I’m looking out two to three years. All the bad news out there helps me accumulate securities at reasonable value. People are starting to see that.”
The S&P/TSX is up 5.1 percent for the year, more than three times a 1.6 percent advance for the S&P 500. Oil on Friday capped its fourth straight week of gains, the longest streak since February 2014.
John Stephenson, chief executive officer of Stephenson & Co. Capital Management, said he would hold a more bullish opinion of Canadian stocks if the record put-to-call ratio were coupled with cheap valuations.
Instead, forward multiples for energy stocks remain “ridiculous” at current levels, he said. Stocks in the S&P/TSX Energy Sector Index are priced at a record 70 times expected earnings, more than double the average of U.S. peers, according to data compiled by Bloomberg.
“It’s hard to say the market is undervalued,” Stephenson said. His firm manages about C$50 million. “I do think there will be a lot more pain, no question about it.”