Derivatives analysts are pondering why equity implied volatility remains subdued, in the face of sharp moves in the credit market. The iTraxx Main was at 53.98% last Wednesday, compared to 40.98% a month before, but the VIX index was at 14.57% last Tuesday, down from 16.56% a month ago. Dealers say now may be a good time to buy equity volatility by entering variance swaps or executing options straddles.
Mike Belin, equity derivatives strategist at Deutsche Bank in New York, thinks market complacency is partly responsible for holding down equity vol. "People are now used to vol being low," he noted. The downgrades of General Motors Corp. and Ford Motor Co. also had a disproportionate effect on the credit market because they are such big debt issuers, he added.
One hedge fund sales official said although it might look appealing right now to play equity volatility against credit volatility, popular capital structure arbitrage trades have come unstuck in recent weeks and this is putting funds off the trade. This was demonstrated when billionaire Kirk Kerkorian's interest in buying a GM stake pushed up the equity value at the same time the downgrade by Standard & Poor's caused GM's bond price to plummet (DW, 5/9).