Photographer: Martin Leissl

Temperatures Gain in German Stocks, Hedging Costs Rise

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The stimulus trade in German equities is crumbling and investors are bracing for the fallout to worsen.

The attached chart shows the cost to hedge against declines in the DAX Index is the highest since at least 2006 relative to the Standard & Poor’s 500 Index, according to three-month Bloomberg data on implied volatility.

dax S&P implied vol

The jump in bund yields and mounting concern about the lack of progress in Greece have German equity investors paying up for protection, JPMorgan Chase & Co. derivatives strategists led by Marko Kolanovic wrote in a note Friday. The DAX slid 7.5 percent from an April 10 record through Friday, after soaring more than 25 percent this year on optimism that a new round of quantitative easing could bring life to the European economy.

“The DAX has rallied explosively this year,” said Michael Purves, the Greenwich, Connecticut-based chief global strategist and head of equity derivatives research at Weeden & Co. “A market that shoots up super fast in a one-sided quantitative easing trade, such as the DAX, is a recipe for higher volatility. That spread is at multi-year highs for understandable reasons.”

Explosive Rally

The S&P 500 added 0.3 percent to a record 2,129.2 at 4 p.m. in New York. The DAX climbed 1.3 percent.

An impasse between Greece and its creditors over the terms attached to its rescue has stretched past 100 days, pulling the country back into a recession and threatening stability in other areas of the European region. The eight-fold surge in the yield on 10-year bunds, the European region’s benchmark sovereign security, has put further pressure on German stocks.

The VDAX Index, a measure of the cost of using derivatives to hedge against moves in the German stock gauge, rose to the highest since July 2012 on May 5. It climbed 5.4 percent to 21.67 last week.

While German equities have quickly reversed course, the S&P 500 has been stuck in an 80-point trading range since February. The Chicago Board Options Exchange Volatility Index, a measure of options costs on the broad-market gauge, slipped 3.7 percent to 12.38 in the five days ending Friday. It has declined 36 percent this year.

“The S&P 500 has been the most dull market in the world,” Purves said. “It’s a war of attrition between the bulls and the bears.”