http://www.bloomberg.com/apps/news?pid= ... refer=newsStock Volatility in U.S. Falls to 10-Month Low, May Not Last
By Jeff Kearns
May 20 (Bloomberg) -- A drop in U.S. 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. The VIX fell as low as 15.82 yesterday after reaching a five-year closing high 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 U.S. 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.
`Don't Be Fooled'
``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.''
The index rose as high as 35.60 on March 17. The S&P 500 has gained 12 percent since that day after the Fed cut its discount rate on direct loans to commercial banks and agreed to back a rescue of Bear Stearns by JPMorgan Chase & Co.
June VIX futures fell 1.9 percent yesterday to 19.76 while August contracts added 0.2 percent to 21.73. October futures gained 0.1 percent to 22.04.
The difference between June VIX futures and contracts expiring in later months shows an average volatility expectation of 21.95 for the eight months starting in July.
`VIX Can Rise'
``For the VIX to come down this fast from 36 to 16 is too far, too fast,'' said Michael McCarty, an options strategist at Meridian Equity Partners Inc. in New York. ``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.''
The S&P 500 slid 9.9 percent in the first three months of the year for its worst quarterly performance in five years. The benchmark for U.S. equities gained 12 percent since its March 10 low this year, and yesterday's 0.1 percent advance pared its loss for the year to 2.8 percent.
Lower VIX levels preceded stock market declines at least twice in the last seven months. The volatility index dropped to 16.12 on Oct. 9 before a 10 percent plunge over the next seven weeks. After the VIX fell to 18.47 on Dec. 21, the benchmark for U.S. stocks dropped 14 percent over the next three months.
``There's a lot of risk still in the market,'' said Ben Londergan, co-chief executive of Group One Trading, the primary market maker for VIX options. ``Inflation's rising, so is unemployment, and I don't see housing prices rebounding for quite a while.''
