Options Signal 3% S&P 500 Retreat as VIX Rises Most Since 2008

By Lynn Thomasson and Jeff Kearns

Jan. 22 (Bloomberg) -- Traders are speculating the Standard & Poor’s 500 Index will fall as much as 3 percent, according to options bets on the benchmark gauge for stock market volatility during the last two days.

Wagers that the Chicago Board Options Exchange Volatility Index will jump 46 percent to 32.5 were the most-active contract. A surge to that level may herald a decline to about 1082 for the S&P 500, said Randy Frederick, director of trading and derivatives at Charles Schwab & Co. The stock gauge slipped 2.9 percent to 1,116.48 since Jan. 20, while the VIX advanced 27 percent to 22.27, the biggest two-day gain since November 2008.

“In the next few days, we’re going to see more volatility,” Frederick said in an interview from Austin, Texas. “The level of complacency earlier was simply too low. A single- day move from 25 to 30 on the VIX could easily mean a 3 percent drop in the market.”

Traders who buy options that pay off when the VIX rises are usually betting stocks will retreat because it moves in the opposite direction of the S&P 500 more than 80 percent of the time. The S&P 500 sank 2.8 percent on Oct. 30, when the VIX last climbed above 30. It retreated 2.1 percent and 2.8 percent when the options measure exceeded that level on July 7 and 8 and June 22 and 23, respectively.

The VIX is derived from investor expectations for market swings over the next 30 days using a formula that incorporates the implied volatility, a key gauge of options prices, for S&P 500 puts and calls that are one or two months from expiration.

Worldwide Decline

Equities around the world have declined since Jan. 20, sending the S&P 500 down 2.9 percent, after the White House proposed to reduce risk-taking at banks and concern grew that China will take more steps to slow economic growth. The Dow Jones Industrial Average tumbled 2 percent yesterday to erase its gain for 2010.

The surge yesterday “was pretty significant for the VIX,” said Stefen Choy, founder of Livevol Inc., a San Francisco-based provider of options market data and analytics. “Maybe people are starting to feel that the market is running out of steam.”

About 64,000 February 32.50 calls on the VIX traded in the past two days. The options gauge, which has averaged 20.28 over its 19-year history, last closed above 32.5 on June 16.

Eighty-nine percent of those contracts changed hands on the ask price, which indicates they were initiated by buyers. The February 32.50 calls have more than doubled since Jan. 20 to 60 cents.

Investors have also sought protection by purchasing shares of the iPath S&P 500 VIX Short-Term Futures exchange-traded note, which added 5.4 percent to $29.32 yesterday. Volume jumped to 11.43 million, the highest since the ETN began trading almost a year ago and more than twice the 4.21 million four-week average. The number of shares outstanding has more than doubled in the last six weeks to 40,447. The VXX, as the note is known, tracks futures for the options benchmark.

VIX futures that expire in March gained 5.4 percent to $24.10 on Jan. 21, while April’s added 4 percent to 24.55.

“You get two days like this and people do start to sit up and notice,” said Carl Mason, head of U.S. equity derivatives strategy at BNP Paribas SA in New York. “People are betting on higher levels of volatility in the short term.”

To contact the reporter on this story: Lynn Thomasson in New York at lthomasson@bloomberg.net; Jeff Kearns in New York at jkearns3@bloomberg.net.
Last Updated: January 22, 2010 00:00 EST