February 5, 2018 / 7:19 PM / 9 months ago

Volatility pop boosts U.S. options hedging activity

NEW YORK, Feb 5 (Reuters) - U.S. equity options traders bought contracts to protect against declining stock prices, driven by the biggest surge in volatility in months, but trading activity on Monday suggested traders are not necessarily hitting the panic button just yet.

U.S. stocks slipped sharply on Monday as rising yields for bonds, which signal higher borrowing costs and are an alternative investment option for traders, continued to fuel the selloff in equities.

The CBOE Volatility Index, better known as the VIX, is the most widely followed barometer of expected near-term volatility for the S&P 500 Index. On Monday, the index was up 4.89 points at 22.2, after earlier rising to 22.88, its highest level since November 2016.

Wall Street has been under pressure from rising bond yields, which led to the S&P 500 and the Dow Jones Industrial Average last week posting their worst weeks since early January 2016 while the Nasdaq Composite recorded its worst week since early February 2016.

Options trading activity on Monday was strong with about 8.5 million contracts changing hands in the first hour of trade, roughly 1.6 times the usual pace, according to options analytics firm Trade Alert data.

By 1 p.m. EST (1800 GMT), overall options trading volume hit 16.5 million, with contracts changing hands at 1.3 times the usual pace, according to Trade Alert.

Options on popular hedging vehicles - VIX, SPDR S&P 500 ETF Trust and S&P 500 Index - drew notable activity.

VIX call options, which profit from a rise in stock market gyrations, were traded at about twice their usual pace. SPY put contracts, which protect against a drop in the S&P 500, changed hands at twice their usual pace.

The robust activity was in line with a spike in equity market volatility rising to a level not seen in months, Jim Strugger, derivatives strategist at MKM Partners in New York, said.

“We have come through such a statistically anomalous period that even if we just go back to average it is going to scare people,” he said.

The VIX’s long-term average stands at 19.34. Through Friday, the VIX had lingered below that level for 312 consecutive sessions.

Still, there is little to suggest that market participants are panicking just yet, Strugger said. “Anecdotally, I am not seeing people really rushing in to put on protection,” he added.

The absence of panic can also be seen in the S&P 500 index skew, a measure of relative demand for puts versus calls.

“Skew has remained fairly stable,” said Mandy Xu, derivatives strategist at Credit Suisse.

One reason why investors may not be more concerned is that while higher bond yields have occasionally driven the VIX up, the effect is typically short-lived, Xu said.

“In order to get sustained high volatility, you need a deterioration in the fundamental outlook which we do not anticipate,” she said.

“Higher rates alone are unlikely to shift the VIX into a high volatility regime,” she said, referring to concerns that interest rates could rise faster than expected.

Reporting by Saqib Iqbal Ahmed Editing by Daniel Bases and Matthew Lewis

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