Pulsing demand for downside Euro STOXX protection sparked a pickup in one- and two-month implied volatility on the Euro STOXX 50 last Thursday, catching dealers and fund managers by surprise. Implied vol hit 15% toward the end of last week, after trading around 13% the previous week, leaving strategists and market players unsure where it would head next.
The price of a put with a 95% strike reached 1.47% at the start of the month, which is cheaper than put spreads have traded in the August of the last five years, according to data from Merrill Lynch. A put spread at the start of the month cost 1.10%. A flow salesman noted, "Everyone's a net buyer of downside puts." He said most trades were out to October or December, with strikes around 32-31. The Euro STOXX 50 was trading at 32.84 last Thursday.
Traders said the demand for puts was all the more noticeable because of a lack of volatility sellers in the market. "It's short term supply and demand," noted Alex Ypsilanti, equity derivative strategist at Merrill Lynch. Hedge funds have been looking to end short volatility strategies after being caught short in the wake of the London bomb blasts, said the salesman, who noted there has been less interest in selling options since the start of July.
But Ypsilanti said the upturn could be the start of a longer trend. There is a relationship between interest rates and volatility, he explained, and interest rates troughed last June. Volatility tends to lag by a year to a year and a half, so this uptick could be a sign it's reached its own trough.
Most hedge funds short one-year and longer-dated implied volatility, but strategists said those playing short dates felt the pinch. The jump was all the more noticeable because realized volatility on the Euro STOXX has been flat at around 10% and stock markets globally have seen strong rallies over the last few months.