Institutional equity fund managers were scurrying to buy cheap put and call options last week as implied volatility drooped toward historical lows. The Chicago Board Options Exchange's benchmark VIX index dropped to 11.84% last Thursday, after hovering at 13-15% for most of last month and touching 17% at the end of April.
One strategist said investors are asking how come equity markets are at multi-year highs, with implied volatility back to multi-year lows. "There's a lot of interest in buying downside equity protection in particular," he noted. Some fund managers believe fears of a hedge fund drawdown, which created turmoil in credit markets last month while only slightly rocking equity markets, are still at large and there may be a time lag in the response of equity indices to this uncertainty (DW, 5/20).
"If you are bearish, puts represent extremely good value," said Mike Chadney, director in investor solutions at Henderson's Global Investors in London. But he noted, "If anything, I am really attracted to long-term call options." There are particularly good access rates to the FTSE100 right now, he noted. One equity fund manager said he was quoted a 10-year at-the-money FTSE 100 call option for a premium of 21%, which means the index would only have to rise by more than 2% a year for the option to pay off.
Not all fund managers have been persuaded by the low vol story, however. Tom Wills, derivatives fund manager at Morley in London, cautioned, "This looks attractive in historical terms, but you also have to look forward." He added, "The implieds are there because the agreed market view is that things look reasonably stable." For fund managers benchmarked to an index, buying put protection is always going to look expensive, he explained, because it will use assets that could otherwise be invested in the index.