SocGen Says Earnings Weakness Means VIX Won’t Fall for a Year

By Gareth Gore

June 2 (Bloomberg) -- The cost of using options to protect against a decline in stock prices may take more than a year to revert to pre-crisis levels as earnings weakness and the economic recession continue, according to analysts at Societe Generale.

Recent declines in options prices may be more to do with a lack of interest in buying the contracts due to the exit of many hedge fund investors rather than a “strong selling pressure,” the analysts wrote in a note to clients, adding that options markets currently provide “poor context.”

“The final leg of the drop might need a bit more than one year to be completed,” they wrote in the report. “We are entering into a transition period where volatility may realize lower but the economic context and corporate figures are still far from being supportive.”

The VIX, as the Chicago Board Options Exchange Volatility Index is known, last month dropped to its lowest since Lehman Brothers Holdings Inc. filed for bankruptcy. The gauge, which measures the price paid for options on the Standard & Poor’s 500 Index, has fallen 63 percent since its November high.

Comparable bear markets indicate that realized volatility, which measures stock swings, tends to take an average of two years to revert to pre-crisis levels, the brokerage said. In addition, markets may remain “volatile” until 2010 as interest rate cuts take time to stimulate the economy, it added.

‘No Longer Active’

Declines in option prices may not signal that the cost of insurance will continue to fall since the exit of large investors from the equity derivatives markets and a “wait-and- see attitude” from asset managers may have distorted the real buying flow of options, accord to the French bank.

“Many hedge funds are no longer active in the equity derivatives market, either because they have been burnt, are underinvested or now focus on other asset classes like credit,” the Paris, New York and Hong Kong-based analysts said. “This poor context reduces liquidity on option markets.”

Put options give the buyer the right to sell shares at a pre-agreed price on or before a specific date. Calls convey the right to buy. By selling an option, the investor is taking a bet the contract won’t be exercised, allowing them to keep as profit the price paid for the call or put.

Options are derivatives, or securities that derive their value from an underlying asset, and can be used to protect against a decline or to speculate on the asset’s future value.

To contact the reporter on this story: Gareth Gore in Madrid ggore1@bloomberg.net.