Volatility Futures Reach 19-Month High on S&P 500 Rally

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Volatility Futures Reach 19-Month High After 24% SP 500

Volatility Futures Reach 19-Month High After 24% SP 500

Volatility Futures Reach 19-Month High After 24% SP 500

Tim Boyle/Bloomberg

The SP 500 pit on the floor of the CME Group’s Chicago Board of Trade.

The SP 500 pit on the floor of the CME Group’s Chicago Board of Trade. Photographer: Tim Boyle/Bloomberg

Futures traders are pricing in the
biggest increase in U.S. equity hedging costs since 2010 after
the Standard Poor’s 500 Index rose within 2 points of erasing
last year’s slump.

April futures on the Chicago Board Options Exchange
Volatility Index settled at 25.15 yesterday, or 6.96 points
higher than the level of the gauge, according to data compiled
by Bloomberg. The gap widened to 7.02 points on Feb. 17. The
last time two-month futures were that high in relation to the
index known as the VIX was July 2010.

The SP 500 has surged 24 percent since Oct. 3 on optimism
Europe will resolve the debt crisis. Now, traders are increasing
hedges to protect against losses, according to Dominic Salvino,
a specialist on the CBOE floor for Group One Trading.

“The consensus bet is that we’re going to have turmoil or
some levels of higher volatility in the future,” Liam Dalton,
who oversees about $1.8 billion as chief executive officer of
Axiom Capital Management Inc. in New York, said in a telephone
interview yesterday. “If you were to talk about a breakdown in
cooperation in Europe, it would affect everything. If the
sentiment goes negative, then you can get these periods of
increased volatility.”

The SP 500 failed to hold above 1,363.61 yesterday,
closing below the almost three-year high reached on April 29.
The index retreated 19 percent between April and Oct. 3 as
concern Greece would default, slowing global economic growth,
intensified. Futures on the equity measure had rallied as much
as 0.7 percent yesterday after European leaders agreed to give
Greece 130 billion euros ($172 billion) in aid.

VIX Above 25

The VIX has declined to 18.19 yesterday, down 62 percent
from a more than two-year high of 48 reached on Aug. 8. It rose
2.1 percent to 18.58 at 11:39 a.m. in New York today. The gauge
stayed above its 22-year average of 20.56 for 117 days between
July and January, the longest period since 2009, data compiled
by Bloomberg show. All VIX (VIX) futures expiring in April or later
closed above 25 yesterday.

“Long-dated VIX has been stubbornly high,” Ralph Edwards,
director of derivatives strategy at Investment Technology Group
Inc. in New York, wrote in an e-mail yesterday. This is due in
part to “the lack of willingness of people to sell long-dated
contracts covering periods over which they have limited
visibility,” he said.

Low valuations for U.S. stocks may help prevent losses for
the SP 500, even if volatility increases, according to David Steinberg, who manages about $300 million as founder of Chicago-
based DLS Capital Management LLC.

Valuations Drop

The SP 500 is approaching its cheapest level ever compared
with bonds as Federal Reserve Chairman Ben S. Bernanke’s zero-
percent interest rates drive investors and companies from cash.
Profits that doubled since 2009 pushed the index’s so-called
earnings yield to 7.1 percent, close to the highest on record
when compared with the 10-year Treasury rate, according to data
compiled by Bloomberg since 1962.

“Equities are undervalued,” Steinberg said yesterday in a
telephone interview. “Investors are coming back to stocks now,
but money isn’t flowing back into the market with the same
velocity as when they flowed out, which is keeping the VIX
fairly low. Stocks may continue to advance even if volatility
should pick up.”

The VIX has tumbled 60 percent since the SP 500 bottomed
on Oct. 3, a record decline over the same number of days.
Declines of 50 percent or more have preceded SP 500 rallies of
about 15 percent on average in the next year, data compiled by
Bloomberg show. That compares with a rolling annual average
increase of about 8.1 percent since 1990 for the equity gauge.

Credit Suisse Gauge

Another measure of concern among options traders rose to a
record high last week as investors pay more for contracts that
gain in value when equities fall. The Credit Suisse Fear
Barometer (CSFB)
, an index of the cost of buying three-month SP 500
puts, funded by selling call options, rose to 30.50 on Feb. 16.

March 1,300 puts, which are priced 4.6 percent below
yesterday’s SP 500 closing level, had the biggest increase in
ownership in the past seven days, adding 30,172 contracts to
171,780. March 1,250 puts, which have the largest open interest
among all SP 500 options, and April 1,200 puts were next.

“People are buying insurance,” Salvino, a specialist on
the CBOE floor for Group One Trading, the primary market maker
for VIX options, said in a phone interview yesterday. “What
we’re seeing is simply the feeling that there’s a lot of bad
things on the horizon, and they’re trying to price some of that
in. There’s a certain level of fear.”

To contact the reporters on this story:
Nikolaj Gammeltoft in New York at
Cecile Vannucci in Amsterdam at

To contact the editors responsible for this story:
Nick Baker at
Andrew Rummer at

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