NEW YORK – Skittishness over the U.S. stock market’s record-setting rally is reaching a crescendo among options traders preparing for a crash.
Investors are paying the most ever to protect against a drop in the Standard & Poor’s 500 Index, data compiled by Morgan Stanley show. The gap between the price of put options on the benchmark for U.S. equities and the cost to wager on further gains has averaged about 8 percentage points since August. That’s more than the previous high in July 2001, before the index dropped 34 percent and fell to the lowest this decade.
A holder of a put option can require the seller of the contract to buy a security at a predetermined price, a useful hedge if that security declines in value.
The widening spread is a warning for OppenheimerFunds Inc. and Harris Private Bank, which oversee more than $300 billion and say the bearish bets indicate stocks may fall. The S&P 500 has rebounded 10 percent since Aug. 15 on speculation that the worst is over for banks and homebuilders hurt by the collapse of subprime mortgages. Shares in developed markets outside the U.S. have done even better, climbing 14 percent from their trough.
“Battle-scarred investors are buying some insurance this time around, having the benefit of hindsight,” said Jack Ablin, who oversees about $50 billion as chief investment officer at Harris Private Bank in Chicago.
Ablin said he bought put options for clients during the rally.
The seven-week rebound in stocks has allowed investors in S&P 500 shares to recoup all the $1 trillion they lost during the biggest plunge in four years. Global indexes fell as defaults on loans to people with poor credit and the worst U.S. housing slump in 16 years caused corporate borrowing costs to increase.
The S&P 500, which dropped 9.4 percent between July and August, rose 2 percent last week to a record 1,557.59, eclipsing the previous high of 1,553.08 on July 19. The Morgan Stanley Capital International EAFE Index of non-U.S. developed markets gained 1.6 percent to 2,336.47, also ending the week at an all-time high.
Mason says implied volatility, a measure that calculates expected price swings of an underlying asset and is used as a barometer for options prices, shows many investors are betting that stocks may fall.
Since Aug. 15, the implied volatility of put options that lock in gains should the S&P 500 drop at least 10 percent in six months has averaged 24.08 percent, according to data from Morgan Stanley, the second-largest U.S. securities firm by market value after New York-based Goldman Sachs Group Inc.
The implied volatility on puts is 8.1 percentage points higher than for call options, enabling investors to profit if the index rises at least 10 percent in the same period. The so-called implied volatility skew climbed as high as 8.53 points since mid-August. That’s steeper than 99 percent of all readings since the start of the decade, Morgan Stanley said. The median difference is 5.9 percentage points.
The gap shows there’s “an awful lot of nervousness,” Mason said. “A lot of investors don’t want to get caught out.”
