VIX Futures Show Traders Boosting Bets on End to S&P 500 Rally

By Jeff Kearns

May 8 (Bloomberg) -- Options traders are increasing wagers that the Standard & Poor’s 500 Index’s 34 percent rally in the past two months is coming to an end.

Futures on the Chicago Board Options Exchange Volatility Index are priced above the gauge’s level of 33.44, according to data compiled by Bloomberg. The so-called VIX, which measures the cost of using the options as protection against market declines, has dropped 16 percent this year in CBOE trading.

Dealers are charging more for insurance after better-than- estimated corporate profits at companies ranging from American Express Co. to Ford Motor Co. and economic reports on home sales and durable goods sent the S&P 500 to its steepest eight-week rally since 1938. Now, the so-called term structure shows higher prices for VIX futures for the next six months.

“It’s fascinating, I’ve never seen anything like it,” said Dean Curnutt, president of Macro Risk Advisors LLC, a New York-based brokerage that specializes in equity options. “You’ve never seen the VIX term structure so high and so flat at the same time.”

Investors surveyed by Macro Risk Advisors expect the VIX to jump to as much as 51.70 by year end, more than double the 20.09 average of its 19-year history. The index won’t fall below 28.1 and the S&P 500 will end the year at 834, according to the average estimates in Curnutt’s survey of 75 money managers and traders at hedge funds, insurance companies and pensions.

The S&P 500’s rally restored more than $2 trillion to U.S. equity markets. The U.S. benchmark index remains 42 percent below its record 1,565.15 reached Oct. 9, 2007.

Lehman Collapse

Options are contracts that give the right though not the obligation to buy or sell a security at a set price and date.

The VIX never exceeded 50 before Lehman Brothers Holdings Inc.’s collapse in September. It topped 40 after WorldCom Inc.’s bankruptcy in 2002, the September 2001 terrorist attacks, Long- Term Capital Management’s collapse in 1998 and the Asian financial crisis in 1997.

The U.S. volatility benchmark, derived from S&P 500 contracts that expire in 30 days, climbed for the first time in a week yesterday, adding 3.1 percent. The VIX has averaged 42.68 so far this year.

May futures rose 1.8 percent to 33.65 yesterday. All contracts expiring by November gained at least 0.2 percent while the difference between the highest and lowest futures contracts was 0.65 point. The S&P 500 declined 1.3 percent to 907.39.

“That’s really unusual,” said Ben Londergan, co-chief executive of Group One Trading, the primary market maker for VIX options. “People are saying, ‘Whatever happens today is setting my expectations for the year.’”

November Record

The VIX has retreated 59 percent since soaring to a record 80.86 on Nov. 20. This year, it hasn’t dropped below the levels it reached when Bear Stearns Cos. collapsed in March 2008 and Lehman failed six months later. The measure closed at 32.24 after the Federal Reserve helped New York-based JPMorgan Chase & Co. buy Bear Stearns and 31.70 when Lehman folded in the world’s biggest bankruptcy.

“People are still nervous about the direction of the market, and they believe we’ll remain in a high-volatility environment,” said Samer Nsouli, chief investment officer at Lyford Group International, a New York-based hedge fund that oversees $65 million. Nsouli said he’s using options and futures to wager U.S. stocks will drop.

Jobless claims dropped by 34,000 to 601,000 in the week ended May 2, the Labor Department said yesterday. That’s still higher than 98 percent of all weekly reports since 1967, according to an analysis by Bespoke Investment Group LLC, a Harrison, New York-based firm that manages money for wealthy investors and provides financial research to institutions.

“There remains an abundance of caution,” said Carl Mason, head of U.S. equity derivatives strategy at BNP Paribas in New York. “People are worried about the rest of the year and we do see people buying longer-dated volatility and longer-dated options.”

To contact the reporter on this story: Jeff Kearns in New York at jkearns3@bloomberg.net.