October Is Forgotten as Credit Suisse Fear Gauge Plummets

By Callie Bost

Photographer: Martin Leissl/Bloomberg

Mario Draghi, president of the European Central Bank, said policy makers are ready to... Read More

If you’re wondering whether the market meltdown of early October left stock investors with any lingering sense of anxiety, it didn’t.
After surging to a record, the Credit Suisse Fear Barometer, which compares bearish to bullish options prices three months from now, retreated to the lowest level in more than a year. Another measure of investor concern, the cost of protection against a 10 percent drop in the Standard & Poor’s 500 Index, has slipped to the lowest in two months amid a record rally in stocks, according to data compiled by Bloomberg.
With stimulus flowing from central banks in Japan and Europe, reports showing the U.S. economy is accelerating and mutual fund managers trying to catch up with
benchmark indexes, stocks are surging anew. The Chicago Board Options Exchange Volatility Index (VIX) has retreated below 14, its average level over the last 12 months.
“We’ve weathered this growth scare correction and two other central banks in the world are ramping up purchases,” Andrew Wilkinson, the Greenwich, Connecticut-based chief market analyst at Interactive Brokers LLC, said in a phone interview. “People are seeing it as the correction is over and long live the bull.”

Global Stimulus

Credit Suisse Group AG’s gauge, which measures how much protection against stock losses can be financed by selling bullish S&P 500 contracts, has plunged 33 percent from a record in September as investors snatched up S&P 500 calls and reduced appetite for puts, according to Mandy Xu, a New York-based derivatives strategist at the firm.
“The earlier drop in the CSFB was more driven by the put side as option investors monetized hedges,” Xu wrote in a Nov. 5 note, referring to the index’s ticker. “The more recent drop is being driven by the call side as demand for upside increases.”
Credit Suisse’s measure of investor fear dropped 0.6 percent to 25.91 last week, touching the lowest level since August 2013. Bullish S&P 500 options cost 8.3 points more than bearish ones, according to three-month data compiled by Bloomberg. The spread between the two, a relationship known as skew, narrowed to the smallest since Aug. 26 last week.
Global stocks recorded the best two-week rally since December 2011 last month as signs emerged suggesting the global recovery is still on track. European Central Bank President Mario Draghi said policy makers are ready to implement stimulus as needed as he signaled officials may cut growth forecasts next month. ECB officials were unanimous in their vigilance, Draghi told reporters after keeping interest rates unchanged.

Japan Stimulus

The S&P 500 jumped 1.2 percent on Oct. 31 after the Bank of Japan unexpectedly increased its target for monetary stimulus and Japan’s public pension fund, the world’s biggest, boosted its target for equity holdings. Volume in bullish S&P 500 options reached a record that day, according to Bloomberg data.
The Federal Reserve’s decision last month to conclude stimulus has done little to deter bullish investors. The S&P 500 has climbed 2.5 percent since Oct. 29, the day the U.S. central bank said it would wind down its asset-purchase program that has helped triple American equity values since March 2009.
Reports last week indicated U.S. economic growth is accelerating in the face of struggling European and emerging-market economies, adding fuel to market optimism. The unemployment rate declined to 5.8 percent in October, boosting the share of the population working to the highest in five years, while U.S. companies added more people to payrolls. Data also showed service industries sustained a faster pace of expansion in October than in the first half of the year.

Bullish Tone

“Everybody loves stimulus, especially if you don’t have to pay for it,” Karyn Cavanaugh, the New York-based senior market strategist at Voya Investment Management LLC, said by phone. Voya oversees $215 billion. “Earnings are doing better, the economy is doing better and other central banks stimulating does set more of a bullish tone.”
Investors piled into U.S. stocks as the S&P 500 rebounded from the worst selloff this year spurred by worries of an economic slowdown overseas. Money flowing to equity mutual funds totaled $4.7 billion in the week ended Oct. 22, the biggest inflow since November 2013, according to data from the Investment Company Institute in Washington.
Options traders followed suit, adding positions betting on a rally in U.S. stocks and swelling the proportion of calls to puts to the biggest in almost five months. Traders own 0.5 bullish options on the S&P 500 for every bearish one, about the highest call-to-put ratio since June.
The cost of calls expiring Dec. 20 with a strike price of 2,175 increased the most of any S&P 500 contracts on Nov. 7, followed by bullish options expiring Nov. 22 with an exercise price of 2,130.

Small Stimulus

The size of stimulus from Japan’s central bank is minuscule compared to the $18.5 trillion market value of the S&P 500, while ECB bond buying “will be a backstop, not a pitching machine,” according to Peter Cecchini of Cantor Fitzgerald LP, who recommends hedging portfolios through index options.
“In neither case do we agree with those that think these actions create massive amounts of liquidity that will find their way to the U.S. market for an extended period,” Cecchini, the New York-based chief strategist and global head of macro equity derivatives at Cantor Fitzgerald, wrote in a Nov. 6 note. “Risk/reward favors protecting books into what we perceive to be a conviction-less chase.”
The VIX, as the gauge of S&P 500 derivatives prices is known, slid 6.5 percent to 13.12 last week. Its European counterpart, the VStoxx Index, rose 3.9 percent to 21.12. Both stock-volatility measures have plunged more than 30 percent from peaks reached last month.
“Protection is a lot cheaper now that the fear has really subsided,” Stephen Solaka, who helps oversee about $200 million as managing partner of Belmont Capital Group in Los Angeles, said by phone. Belmont Capital trades S&P 500 options. “There’s still demand for hedging, but people just aren’t as interested as they were before. The market has been resilient. People have quickly forgotten the selloff.”