December 17, 2014 / 5:32 PM / 3 years ago

Wall Street's 'fear gauge' may not recede before year-end

NEW YORK (Reuters) - Just when it looked like Wall Street’s fear gauge would settle down for the holidays, it has been on the rise again, and a jump in the cost of hedging suggests that volatility might be here to stay at least until year-end.

The spike in the CBOE Volatility Index, which by Tuesday had sent it to a two-month high of 25.20, has come within a span of eight days. Past surges in the VIX would suggest that it may continue to rise for a few more days.

The surge in volatility in December, usually a calm month for markets, took many by surprise. U.S. equity markets hit all-time records early in the month, but since then, the sharp drop in oil prices, expectations for the Federal Reserve to start to indicate plans to raise rates, and turmoil in Russia has brought out sellers.

While the VIX is typically driven primarily by swings in the S&P 500, any number of factors could still push the VIX higher.

“Any really, really surprising news on oil, Russia or Europe could make the VIX go much higher,” said Ophir Gottlieb, chief executive of Los Angeles-based Capital Market Laboratories.

Moreover, measures of the cost of hedging using options on the VIX shows more investors - some caught unawares by the VIX’s recent surge - are bracing for further market gyrations.

One way to measure the cost of hedging with VIX options is to look at the VVIX Index, the volatility index for VIX options. On Friday the VVIX touched 141.66, highest since Oct. 15.

There would have to be considerably more volatility going forward to justify current options prices, BGC Partners Inc equity derivatives strategist Jared Woodard said.

“People weren’t ready for this action and as a result the last three or four sessions we have seen people trading who otherwise were content to let things wrap up for the year,” Woodard said.

This has resulted in higher-than-usual volume for VIX options in recent days.

To be sure, not all investors are convinced that higher volatility is in the offing. Growing open interest in VIX puts suggests that some traders are beginning to bet the market might start to calm down a bit.

The ratio of VIX puts-to-calls open interest has been on the rise over the last eight trading days. On Wednesday it touched 0.59, the highest it has been this year, according to Trade Alert data. Buying VIX puts is typically a bet on lower volatility.

On average, once spot VIX has risen above the 14 level, it’s taken 13 days to peak, Jim Strugger, derivatives strategist at MKM Partners said. The VIX breached the 14 level on Dec. 8, and Strugger believes the VIX won’t peak until around Dec. 24.

Reporting by Saqib Iqbal Ahmed; Editing by Christian Plumb

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