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U.S. options hedging muted even as stocks approach February lows

Stock Markets Apr 04, 2018 01:20PM ET
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© Reuters. Traders react as they work on the floor of the New York Stock Exchange shortly after the opening bell in New York
 
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By Saqib Iqbal Ahmed

NEW YORK (Reuters) - Activity in U.S. equity options was slow on Wednesday even as stock indexes flirted with February lows, as expectations for strong corporate earnings quelled the urge to load up on contracts that benefit from a surge in market volatility.

Global markets reeled on fears of deepening trade conflict between China and the United States after China hit back on Wednesday against U.S. plans to impose tariffs on $50 billion in Chinese goods, retaliating with a list of similar duties on key American imports.

The S&P 500 (SPX) fell as much as 1.6 percent to come less than 2 percent away from the low of 2,532.69 in early February, before trading little changed on the day.

The Cboe Volatility Index (VIX), a widely followed barometer of expected near-term volatility for stocks, was up 0.8 points at 21.9. By contrast, it hit 41.06 when the S&P 500 bottomed in February.

"There is definitely a level of complacency," said Andrew Thrasher, portfolio manager at Financial Enhancement Group, in Indianapolis.

"Not only is it being shown in the VIX and the VVIX but if you look at the term structure for the VIX it's extremely flat," he said, referring to the VIX futures curve, which reflects the market's expectation of future volatility of different time horizons.

A flatter VIX futures curve indicates little expectation for increased stock market gyrations.

The Cboe VVIX Index (VVIX), an indicator of the expected swings in the VIX, was at 99.45, not far away from its average reading of 90 for 2017, a period of extremely low stock market swings.

Expectations for a solid earnings season may be keeping fear in check, Thrasher said.

"Coming out of the recent tax changes, there is probably some expectation that earnings should be positive," he said.

Trading volume for VIX options, used to place bets on future stock swings, was at 285,000 contracts, or 85 percent of the expected volume, according to Trade Alert.

Other popular hedging vehicles, including options on S&P 500 Index (SPX) and its tracking ETF's (P:SPY) also showed muted activity.

"There is not a mad rush or increased volume in the broad-based indexes and ETFs," said Jon Cherry, head of U.S. options at Northern Trust (NASDAQ:NTRS) Capital Markets in Chicago.

Instead, investors were looking to make the most of the spike in stock swings.

"What we have seen early this morning is an increased number of investors looking to sell covered calls on single name securities," said Cherry, referring to a strategy in which investors sell call options against stock holdings. Increased volatility tends to boost the returns from such sales.

U.S. options hedging muted even as stocks approach February lows
 

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