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Protection against post-QE euro stocks swings still cheap
June 18, 2013 / 1:07 PM / 4 years ago

Protection against post-QE euro stocks swings still cheap

* Volatility expected to increase as end of QE3 nears

* VSTOXX jumped to more than twice current level after QE2

* Cost of options rise most for June expiry, cheaper later

By David Brett

LONDON, June 18 (Reuters) - Demand has risen for short-term protection against European share price swings but investors can still insure relatively cheaply against the volatility expected to follow any Federal Reserve move to cut back stimulus.

Worries the Fed could “taper” the stimulus that has helped subdue interest rates and inflate equities later in 2013 have seen European stocks fall 7 percent since mid-May.

In turn, implied volatility - a crude gauge of investor “fear” which tends to move in the opposite direction to equities and is bought by some to insure against a fall in stocks - has jumped 30 percent, based on the VSTOXX index.

But the moves in both equities and volatility have so far been very modest compared with what happened during recent periods of Fed stimulus unwinding, suggesting more is likely.

With the market so far most actively seeking to insure against a big move this week, when the Fed holds a policy meeting - by buying June options expiring on Friday - investors can still put on longer-term trades relatively cheaply.

“We will see new lows in volatility in the next couple of weeks (after the Fed meeting) and then might be the time, if you have a bearish view, to pick up some protection because overall, buying protection is still relatively cheap,” SG equity derivatives strategist Vincent Cassot said.

The scale of predicted future price movement, or volatility, remains low on longer-term contracts.

The price of a call option - the right to buy - on implied volatility in EuroSTOXX 50 euro zone blue chips, as measured by the VSTOXX, just below current levels, has jumped 70 percent for the June contract since May 22, according to Eurex.

The cost of such a bet for September has risen just 28 percent, and is up only 17 percent for the December contract.

“Today’s situation does show that short-term maturities are relatively expensive and that longer tenors are relatively cheap,” Hans Corsten, managing director at Dutch-based volatility data analysis firm SIGMA28.

That could change if the Fed begins to scale back its quantitative easing (QE) programme of buying some $85 billion per month of Treasuries and mortgage-backed securities in coming months.

When the Fed has scaled back QE previously the European equity market has dropped by up to a third in the following weeks and volatility has spiked.

The VSTOXX peaked just short of 39 after the Fed's first bout of QE ended in 2010, and hit 46 - more than double current levels - after the second bout ended the next year.

The pick-up in implied volatility on European equities has been steeper than that on U.S. stocks. This partly reflects the more supportive fundamentals in the United States - and thus less reliance on central bank stimulus - and highlights concerns about political tensions within the euro zone.

“Opportunities to buy protection are still very relevant ... Protection out to the year-end or towards March next year makes a lot of sense,” Simon Carter, derivative strategist at Deutsche Bank said.

He recommended buying December puts, bets the market will fall, on the German DAX and betting on a rise in the VSTOXX via a call spread. In such a structure, an investor offsets the cost of buying a call option by selling one at a higher strike price.

Now might be the time to take out such protection while the massive central bank liquidity programmes are still in place and risk-averse asset managers are still relatively under invested.


Some investors are already making their move, putting protection in place against future falls. Total open interest in EuroSTOXX 50 puts has risen 8 percent in the past three weeks, versus 5.7 percent for calls, according to data from Eurex.

Bernard Kalfon, head of volatility strategy and risk management at Geneva-based Union Bancaire Privee, which has 83 billion Swiss francs ($90.1 billion) in assets under management, is among those buying put options on equity indexes.

“We are at a turning point for markets and volatility will be higher than what we’ve recently seen ... In such an environment you need hedging strategies,” he said.

“With hedges, you can go long and sleep at night.” (Additional reporting by Blaise Robinson, editing by Toni Vorobyova and Nigel Stephenson)

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