A DROP in US stock volatility to the lowest level since July may prove temporary as traders boost bets that the benchmark index will rise 36 percent in two months.
The Chicago Board Options Exchange Volatility Index, or VIX, tumbled by more than half since March as stocks rallied from their lows of the year after the Federal Reserve backed the bailout of Bear Stearns Cos. According to Bloomberg News, the VIX fell as low as 15.82 on Monday after reaching a five-year closing high on March 17. Traders expect it to rebound to 21.58, July futures show.
"People are unwinding their short-term hedges and putting on long-term hedges, so that's depressing the VIX," said Simon Emrich, head of North American Quantitative Derivatives Strategies at Morgan Stanley in New York. "Once investors have completed resetting their hedges the VIX should come back up."
The VIX, calculated from prices paid for Standard & Poor's 500 Index options no more than 30 days from expiration, doesn't reflect expectations beyond that period. The futures, which have longer maturities, show investors expect more US stock volatility for the rest of this year.
Higher readings in the VIX, which measures the cost of insurance against declines in the S&P 500 Index, indicate traders expect larger share-price swings in the next 30 days. The VIX is considered a stock market fear gauge because it usually rises as stocks fall.
Traders are speculating record oil prices and the deepest housing slump since the Great Depression will lead to wider stock swings, said David Krein, president of DTB Capital LLC. The index rose 3.3 percent yesterday to 17.01 after earlier dropping as much as 4 percent.
"VIX futures are pricing in near-term risk" for the stock market, said Krein, whose New York-based firm advises hedge funds on derivatives and structured transactions. "Don't be fooled by the VIX at 16."
Michael McCarty, an options strategist at Meridian Equity Partners Inc in New York, said: "For the VIX to come down this fast from 36 to 16 is too far, too fast.
"June and July futures are pricing in a higher VIX. There's a lot of room above here that the VIX can rise and I expect that it will."